Exit plans – COVID-19 or not

Exit plans – COVID-19 or not

Many business owners who were considering an exit may have been reviewing their plans after the Chancellor’s changes to Entrepreneur’s Relief in March, even before COVID-19 provided a further complication.

There is the additional concern in the current situation that valuations will be negatively impacted, at least until the business can demonstrate a sustained period of recovery, and preferably growth. However, some business owners may have been waiting since the previous downturn for valuations to recover to meet their expectations and they are now faced with an additional delay to their plans. What the current situation tells us is there is no certainty and therefore business owners should consider their personal and professional positions, together with their aspirations, and review all options.

COVID-19 impact on succession planning

The taxation regime is regularly under review by Government but the range of Government measures that were put in place to react to COVID-19 has introduced a new impetus to this process as the Treasury seek to balance the books. This may be an additional factor in business owners considering their plans for the next year or so.

Internal succession options

Management buy-outs

We have seen an increase in the number of management buy-outs in recent years, as owners seek exit routes that can reconcile their wish for an exit at a fair value in a way that continues the business in the legacy they have established. In addition, in times of uncertainty, the management team are the people who understand the business best and this can smooth a transaction as they will understand the risks, benefits and the ways the business can emerge from the situation.

Employee Ownership Trust

A different type of MBO structure is the Employee Ownership Trust (EOT). This is where the current owners sell the company (or a majority thereof) to a Trust which has all of the employees as beneficiaries. This structure is currently the most tax efficient for the Vendors as tax relief reduces the capital gains tax rate to 0%.

There are famous large EOTs such as John Lewis, but there are also SMEs that are wholly, or majority owned by an EOT such as Aardman Productions.

Funding Options

Both structures can be achieved in a range of ways that may or may not need external funders. For example, Vendor funded and Deferred MBOs or EOTs can be achieved with less or no external funding.  The former (vendor funded) requires no external funding where the owner is happy to exit immediately. The latter structure (deferred) is used when the owner wishes to exit in stages whilst maintaining a degree of control over the process. In a Deferred MBO or EOT, the initial stage should set out the mechanisms for the complete exit at a future point in time.

The exact form of these deferred mechanisms will depend on the nature of the parties, their plans and working relationship. Where the full exit value is not confirmed up front, issues that need to be agreed include the valuation method (i.e. relevant earnings, multiplier and any debt calculations), indicative timing, and any key conditions e.g. retaining a key contract.

This additional layer of detail provides clarity for the buyers team in terms of their direction of travel and enables the vendor’s advisors to review the tax position carefully and seek any clearances in advance.

Successful succession

Any exit will include a handover role for the exiting shareholder, but arguably it becomes more important in a deferred structure. This is because, under both methods, the owner is not receiving all of their consideration up front, and value and cash needs to be generated between the stages. These models also provide the MBO team with time to develop their roles and complete the handover while the owner is still engaged as a result of the deferred consideration or stage payment. This provides an opportunity for a structured programme to be put in place to ensure a smooth handover by the date of the final transaction.

It is important that this time is used positively with the exiting team stepping back and the new team stepping up to take their place. It also provides time for the advisors to work with the management team to ensure they clearly understand financial information, start to think strategically and line up any funding required for the final transaction.

Azets specialist corporate finance and tax specialists work together to help structure the most efficient exit route, which is particularly important in these two situations. If you wish to discuss your succession plans, or are a management or employee team who wish to discuss a potential transaction, please contact Katherine Broadhurst.