The mechanics of a management buy-out

There are two main structures for management buyouts, and the right one for your situation will depend on factors such as how the transaction will be financed.

Company purchase of own shares (CPOS)

The company effectively buys back and subsequently cancells the shares held by those individuals exiting the business.

While this is generally more straightforward to implement, particularly from a legal perspective, and therefore cost effective, it is only suitable in certain circumstances.

For example, it requires that all consideration owed to the exiting shareholders is settled in full on completion, with no ability to pay the consideration to the shareholders on a deferred basis.

In addition, the company must have sufficient distributable reserves (shown on the balance sheet) to match the proceeds, whilst leaving adequate cash in the business post-sale for the company’s working capital requirements.

Proceeds received by the exiting shareholders are treated, as standard, as a distribution subject to income tax rather than capital gains tax.

There is strict criteria which must be met to secure capital gains tax treatment.

Newco buy-out (Newco)

A new company is formed to acquire the entire issued share capital of the existing company from the current shareholders.

Those exiting the business are paid for their shares, and those intending to continue simply receive shares in Newco to replace their old shares. The consideration can include deferred elements if required, giving more flexibility in settling the consideration.

The conditions which need to be met in order for the proceeds paid to the exiting shareholders to be assessed under capital gains tax, are more easily satisfied under a newco buyout than a CPOS.

The new owners can determine the ownership structure of newco.

In both options, it’s recommended that advance clearance is sought from HMRC in order to ensure all the criteria is met for agreement on the tax treatment.

In the majority of cases, a newco buy-out is likely to be the preferred route, as payment is more flexible with fewer potential tax and commercial issues for both exiting and ongoing shareholders.

In addition, a CPOS is only appropriate where there will be no new shareholders, whilst the newco buy-out allows for both new and existing shareholders.