Directors must be confident they have sufficient cash to pay creditors after using funds for the share buy back.
We can assist Accountants. Come to us to make sure you get the paperwork right.
Can a company pay for a share buyback in instalments, if it cannot afford to pay the share seller in one payment? Answer: Yes. A share buyback can be made in stages. There are traps and procedures to follow as we explain.
Structuring share buybacks in tranches
Share buybacks are fairly common – see our general guide to share buyback. They are a good way to resolve shareholder disputes. However, disputes often arise when the company lacks cash. Then the company cannot afford to buyback the shares in one payment.
The share buyback must be made from distributable reserves. Distributable reserves are similar to working capital. Directors must be confident they have sufficient cash to pay creditors (and not just short term creditors) after using funds for a share buy back or may face legal problems if the company later becomes insolvent.
One of the great advantages to the share buyback regime is that it is possible to obtain advance clearance from HMRC that they do not consider the transaction to be for the avoidance of tax
So, many directors of cash strapped companies feel more confident if they pay for the shares in instalments. We can put in place a structure to achieve the flexibility needed.
Structuring a share buy back in instalments
First, the directors agree the price for the shares bought back. The valuation is not always clear cut for private companies with no trade sale. Private company valuation is an art. As far as HMRC concerned the directors only have to be reasonable. Second, the directors calculate a comfortable cash flow forecast.
Share buybacks – hidden traps
We commonly encounter five risks. There are others but we have picked out the most common mistakes :-
- Retention of rights in shares – The seller may remain entitled to certain rights attached to the shares being bought back until they are fully paid for, if we don’t amend the articles and/or shareholders’ agreement. If a shareholder still holds legal title to shares HMRC consider they are still able to exercise their voting rights at a company meeting which would destroy any claim to tax beneficial capital treatment. We can look at the voting position for you to see if there are solutions which could get around the problem.
- Tax problems – If the seller does not satisfy various HMRC conditions when signing the buyback agreement, then HMRC will tax the share buyback as dividend income which is a much higher rate of tax than that applicable to capital receipts.
- Has the company bought back sufficient shares on day 1? – this is linked to the way HMRC may interpret the tax position. Generally, a seller’s shareholding is “substantially reduced”, if, on day 2, the seller’s shareholding, expressed as a percentage, is not more than 75% of the seller’s holding prior to day 1. For this test you have to calculate the number of shares being cancelled and include that in the calculation.
- Does the departing shareholder remain a Director until all instalments are paid? – It may be possible for the seller to remain a director, providing the remaining shareholders retain control, and can out vote the “seller director” at board level. The rules are complex. Often we recommend that voting rights are removed. Generally speaking, it is better if the director/employee resigns shortly following completion of the buy-back.
- Misjudging the required cash flow – Does the company still have to pay if the company’s reserves are not as healthy as forecast? The company must have sufficient distributable reserves to pay each and every instalment. From the company’s perspective giving the seller security is unattractive. What if the company doesn’t pay? Is the seller then a creditor with an undisputed debt? We avoid problems by thinking through the possibility of delaying payments.
Catherine Gannon
02074381060 | catherinegannon@gannons.co.uk
Catherine is an extremely experienced solicitor, having been qualified since 2000, and deals with all types of corporate and commercial matters and advice and also tax law.
Catherine is well known for turning complex problems into solutions, priding herself on always finding a way. In her spare time she runs Gannons!