21 March 2017
A partial exit can help to release some of the equity built up in your business, but it's important to think through all the implications before you act.
A partial exit can be an ideal way to release some of the equity you have built up in your business. It can also inject additional funds to really drive your business forward. But make sure you think through all the implications before you act.
Traditionally, if you wanted to release the capital value locked up in your business you had two options: you could sell it or go for a stock market flotation. But what if you don’t want to expose yourself and your company to the very public gaze of being a quoted company? What if you feel you still have much to contribute to the development and growth of your business? What if you don’t want to sell your controlling stake? Then you might consider a partial exit, selling some of your capital to a new private investor.
You might also be attracted to a partial exit if you want to protect your position. After many years of hard work, all of your wealth is likely to be tied up in one investment – your business. De-risking that situation could be a sensible step.
Deciding on the amount of shares to sell can be a delicate balancing act. You want to realise some worthwhile value, but you don’t want to create the perception that you are no longer committed to the future success of the business.
Retaining a controlling stake is particularly important if things don’t go to plan. Given your knowledge of the business, you may still be the best placed person to make key decisions. To ensure you have the necessary power to do so, however, you need to retain control, which in practice means retaining a majority stake.
In general, a partial exit is most likely to succeed if you retain a good level of control of your business. If you wanted to relinquish control on the other hand, a full sale is probably the better route.
When seeking a partial exit, you need to think about what will attract potential investors. Firstly, they will want to back a well-established, successful business that is growing. If that’s not the case, they are unlikely to be comfortable swapping their equity for yours!
It’s also important to note that transactions involving partial exits are typically structured with as much debt as possible. So having a business with strong cash flows to facilitate the debt is a must.
As noted, you will need to demonstrate that you are still committed to the business going forward. If you are seeking a more passive role, you will need to show that your management team is good enough to run and develop the business successfully without your daily input.
Whether you are actively involved or not, the ongoing management team must be able to demonstrate that the business is capable of growing – at least at the same rate as it has achieved historically. Ideally, the investor will be seeking even faster growth following the extra cash injection.
The tax treatment of a partial exit will be determined by the terms of the deal, so it’s crucial to consider the exact structure in order to achieve the best tax outcome.
If your investment is held personally, Capital Gains Tax (CGT) would normally be due on the gain arising on the sale of shares. From 6 April 2016 the rates of CGT, with the exception of sales of residential property, are 20% for higher/additional rate taxpayers and 10% for basic rate taxpayers. However, assuming that you are also an officer of the company and hold at least 5% of the share capital, Entrepreneurs’ Relief may also be available. This would result in the CGT payable being reduced to 10% for higher rate taxpayers (subject to the £10 million lifetime limit).
If the shares are not held personally and are instead being sold by a holding company owned by you, corporation tax would normally be chargeable on the gains arising on the sale. This is unless the conditions can be met to enable a claim to be made for substantial shareholdings exemption, which would result in a complete tax exemption of the gain/loss from the sale.
Finally, if the terms of the deal involve non-cash consideration, such as the issue of shares or debt in the new investor’s company, any chargeable gain on that portion of the proceeds may be deferred until the later sale of the newly acquired shares or redemption of the newly acquired debt, provided important conditions are satisfied.
If you are considering a partial exit, make sure you carry out as much due diligence on your potential investor and their team as they conduct on you and your business. Think carefully about whether you can work well together and try to gain an understanding of their approach and the team they have allocated to your business. It’s likely that they will seek to be actively involved and will want to contribute to the success of their investment, which means you will see a lot of them – particularly if things don’t go according to plan. If possible, try to talk to other companies where your investor has a stake to get some direct insights into their management style to ensure it accords with your own expectations.
Your investor is likely to seek an exit from your business by completing a sale within three to five years. You need to assess whether the preferred timeframe is in keeping with your own plans, because it’s highly likely that you will be exiting at the same time.
If you’d like to find out more about how to achieve a partial exit, please do not hesitate to get in touch.