If you are an owner-managed business but want to maximize the proceeds of the sale upon closing (and avoid a profit structure), you need to hire a new management team before you exit to prove to the buyer that they are not doing that. We will not require you to remain in business to perform any administrative or sales functions to maintain profitability after completion.
But what kind of compensation package will you need to offer to hire and motivate the management team before you exit the business?
Obviously one element of this package is offering market rate salaries, which could have a negative impact on the company's earnings before interest, tax, depreciation and amortization (EBITDA), as as is the case with many companies, the owner's salary prior to the sale was modest with a raise coming in the form of Dividends paid on shares.
The second element is to provide some form of incentive on stocks. This can be in the form of stocks, options or fictitious shares.
'Phantom shares' mean little more than an additional cash payment from the company or seller to the principal depending on the level of sale proceeds achieved on exit and are tax inefficient as they will be subject to income tax and National Insurance.
By contrast, if you issue shares to management, they can benefit from dividends before the sale and gain capital on the sale. If properly structured, the issuance of shares can be more tax efficient than phantom shares. But as you issue physical shares, you should consider including provisions in the shareholders' agreement or company's articles of association to ensure that: (1) any voting rights associated with management shares are not sufficient to enable you to disrupt your day-to-day management of the company, (2) that you can easily recover Shares or forfeit if a director leaves or is terminated prior to exit, with appropriate valuation and vesting provisions for good, bad and average leavers and (3) that on exit itself you can also ensure that directors sell their shares alongside you, usually by including a 'drawdown' right.
It is important to obtain tax advice so that shares are not viewed as bonuses and subject to PAYE and National Insurance (which can be difficult) and the manager receiving them will need to understand potential future capital gains tax (CGT) (or income tax) liabilities.
Under current rules, CGT is payable on the sale of shares at 20% unless (among other conditions) they are held for 24 months where they may be able to qualify for business asset disposal relief and a 10% tax rate on the first £1. . 1M of profit.
An alternative to issuing shares is to grant options under the Enterprise Management Incentive (EMI) scheme available to companies that meet certain criteria including (but not limited to) – total assets of £30 million or less, fewer than 250 full-time employees, and full-time employees for at least 25 hours per week and the value of the shares is limited to £250,000 and can be awarded to each individual.
The advantages of EMI options over issuing shares include: (1) Options can be written to be exercisable only on exit and to lapse if the manager leaves before exit without the shares having to actually be transferred or forfeited. (2) that there is no need for management to pay for its shares until cashless exercise on exit when the proceeds of the sale are available to fund that payment and (3) that there should be no risks to the company associated with voting by directors or dealing with minority shareholders.
You will of course need to allow time for the incoming management team before the proposed exit to not only take over the day-to-day management of the business but also to demonstrate that under their management it is equally and reliably profitable as it was before under your day-to-day control. The length of this period will depend on the nature of the business and the particularities of the intended buyer, but can be extended to one or two years to enable the buyer to see a track record of success under the new management team to reassure the buyer. That the team is capable.
As always before planning an exit from a business, give yourself time to think about the outcome you want to achieve and build the best strategy to help achieve it.
