Case study – spinning out a business

Gannons was approached by two brothers who ran a recruiting business but were also diversifying into recruitment software.

Investors had suggested that they were keen to invest in the software business but not the recruitment business. Therefore, Gannons was instructed to consider the ways to spin the software business out of the recruitment business.

Spin out using capital reduction demerger

We recommended that we follow the route of a “capital reduction demerger” as this allowed the directors and shareholders to split their businesses into separate recruitment and software businesses in a tax neutral way and be operated independently.  It is a good deal for the shareholders because they are effectively transferring shares and becoming shareholders in two businesses without:

• paying any stamp duty, which is normally paid when shares are transferred; nor
• paying capital gains tax on the creation of assets in the form of two businesses.

Key issues we dealt with

The capital reduction demerger route required shareholder approval and a solvency statement. In our case the directors had no concerns about insolvency.

We implemented a share for share exchange to place a company with a high share capital at the top of the group. The result was that this new company, Recruitment Holdco Ltd, had share capital equal to the market value of the existing group.

HMRC clearance for the holdco

We obtained HMRC clearance that putting in place the new holding companies did not trigger any CGT charge for the shareholders, nor the companies on the exchange of Peter and John’s shares in Recruitment Ltd for Recruitment Holdco Ltd.  There was no stamp duty on this transaction and we obtained clearance from HMRC to confirm the point.  The subscription value of the Recruitment Holdco shares represented the market value of the Recruitment Ltd and there was no physical outlay of cash.

Reduction of share capital

To achieve the demerger Recruitment Holdco reduced its share capital. The capital reduction reflected the market value of the assets transferred to Software Ltd and hence it represented a return of capital as opposed to income distribution. The shareholders did not incur an income tax charge on the transaction.

The share capital once reduced equalled the value of Software Ltd transferring over to the new Software Holdco.

The consideration for the reduction in share capital in Recruitment Holdco was the transfer of shares in Software Ltd.

Final steps

The demerger was documented in a tripartite agreement (also called a demerger agreement). Tax clearance was obtained from HMRC, which gave the taxpayers, our clients, peace of mind. Numerous filings were prepared and sent to Companies House. We also dealt with EMI option holders. Software Ltd went onto raise funds under EIS and we helped them with that.

Reorganisations are often an effective way of resolving shareholder disputes, often between families, by dividing up the assets.  Many investors and/or purchasers are interested in part but not all of a business. Reorganisations or demergers are often the perfect solution.