Are partners really self employed?
2 October 2018
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.
Share buybacks are fairly common. 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 after using funds for the share buy back.
Directors of cash strapped companies feel more confident if they pay for the shares 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.
Second, the directors calculate a comfortable cash flow forecast. For example, the company buys back 1000 shares for £1m, as follows:
Thus the company maintains adequate distributable reserves throughout the year.
The above structure is workable. However, care is required. The share buyback risks being void. Sellers face new tax risks. We commonly encounter five risks:
The seller may remain entitled to certain rights attached to the “sale shares”, if we don’t amend the articles and/or shareholders’ agreement. The seller may even remain the legal owner of the tranche shares. Thus we often:
If the seller hasn’t held the shares for over five years, when signing the buyback agreement, then HMRC taxes the instalments as dividend income. There is no avoiding this. HMRC taxes the consideration as a capital payment if the seller:
Assessing conditions 1, 2, and 4 is usually straightforward.
When paying in instalments, ensure you meet condition 3. Otherwise, this causes problems.
A seller’s shareholding is “substantially reduced”, if, on day 2, the seller’s shareholding, expressed as a percentage, is less than 75% of the seller’s holding prior to day 1.
Suppose the seller holds 1000 shares. The company’s share capital is 5000 shares, all of the same class:
Hence, the day 1 payment is usually the largest instalment.
There are rumours that HMRC’s stance is changing. The change is:
Thus, the seller must remain an employee or director during the tranche period. However, it is impractical for a seller to remain an employee, as a nominal salary will not be attractive to a seller.
It may be possible for the seller to remain a director, providing:
We amend the corporate documents. The rules are complex.
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? If so, perhaps the seller could serve a statutory demand and winding up petition.
Clearly the company should avoid this risk. Perhaps, the instalment payment could be a preference payment capable of being avoided by the liquidator.
We avoid problems by thinking through the possibility of delaying payments. Otherwise the company could face a breach of contract claim from the seller. We suggest negotiating flexible solutions, e.g. a clause that the share buy back due under instalments that the company is incapable of immediately funding “rolls over” to a future date.
We obtain HMRC clearance for the tax elements. However, HMRC does not confirm entrepreneurs’ relief, but we can confirm if it is available. In addition, you need to factor in time to obtain shareholder approval.
We often see oversights and errors. You can avoid many problems if both parties know the issues before commencing the deal.