Locking in Value: structuring the deal

As introduced earlier in this series of articles, the sale of a business is a process with a timeline.

Previous articles have considered key aspects of that process and their place in the timeline: most recently, the planning in the pre transaction phase, before the purchaser has been identified or even actively sought. What follows, of course, is the identification of the purchaser.

Intuitively, the identification of the purchaser and negotiating the terms of the Sale and Purchase Agreement (SPA) should mark the culmination and end of this process.

This is not the case. It is, however, a critical phase in the process when value can be “locked in” for the benefit of the vendors.

Negotiating one headline price at one point in time (the time of the SPA) is generally in neither party’s best interest, vendor nor purchaser. The vendor’s shareholders are concerned to achieve a price for the business that reflects their assessment of its future profitability and potential for growth.

The purchaser may be willing to pay such a price, but only when that profit and/or growth is delivered or is at least reasonably assured.

The confident expectations of the vendors need to be reconciled with the, understandably, more cautious view of the purchaser. The “earn out” is the mechanism that seeks to achieve this.

The “earn out” simply describes a mechanism under the SPA for delivering additional consideration to the vendors payable by reference to the future performance of the business.

This performance will be assessed by reference to agreed metrics included in the SPA, typically EBITDA or some other measure of profit over a defined earn out period of, usually, up to three years.

The taxation of the earn out is one of the most complex aspects of the deal. In terms of maximising post tax returns for the vendors, it is important to ensure that the earn out is taxed as further consideration for the shares sold.

The key here is making certain that the favoured 10% rate of entrepreneur’s relief applies to the earn out consideration (and not higher rates of capital gains tax or even income tax.

Negotiating a favourable earn out is a key component in structuring the deal. The other main elements concern what is to be sold (shares or assets) and how the consideration is to be satisfied.

The question of what is to be sold, whether shares in the company or the trade and assets of the company should be resolved at an early stage. It is almost invariably in the vendor’s interest to sell shares, not least in terms of maximising the after tax return.

It is equally the case that the purchaser’s interests are best served under an assets deal (securing tax relief for their purchase consideration and avoiding the risks of acquiring the company with its unknown liabilities).

Any thoughts of indulging the purchaser’s concerns over their tax efficiency and simplifying the deal (an assets deal will generally minimise the need for extensive warranties and indemnities) should be firmly rejected at the outset.

An assets deal represents a zero sum game between the vendor and the purchaser, as any tax relief achieved for the purchaser, by way of amortisation for tax purposes of the goodwill in the business acquired, gives a corresponding corporation tax liability to the vendor company on the gain realised on the disposal of that goodwill.

The purchaser will generally accept the vendor’s position here (and may be more easily reconciled to it as a result of proposed changes which will remove the benefit of tax relief for the amortisation of goodwill acquired).

As to the consideration payable under the SPA, cash is always king. Loan notes or debt should be supported by appropriate securities or bank guarantee. Equity in the acquirer may be offered and may be attractive. However, it should be recognised that this is essentially an investment decision. If the purchaser has a full listing, the investment is in the nature of a portfolio investment. Where the purchaser is unlisted (or does not have a full listing), it is in the nature of private equity investment and the risk and rewards should be viewed as such.

As with the earn out, it will be important to consider the entrepreneur’s relief position on an eventual realisation of these consideration shares and plan accordingly.

Negotiating the SPA is not the end of the sale process. It addresses key structuring issues in terms of the mix, timing and parameters of the overall consideration and the subject matter of the transaction: assets or shares.

It sets the framework for the exit achieved and, hopefully, triggers a substantial down payment in respect of the shares or assets sold.

However, the hard work of delivering the value locked in under the earn out commences. The sale process continues – even in the ownership of the purchaser!


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Neil Simpson

Tax Partner at haysmacintrye, Neil advises on a range of tax issues focusing on transactional matters and tax structuring, particularly for early stage businesses and those preparing for, or seeking an exit. He has wide experience of advising on the impact and mitigation of direct taxes in the course of business transactions generally and those related matters as they impact on the owners and their key employees.

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Tax Partner at haysmacintrye, Neil advises on a range of tax issues focusing on transactional matters and tax structuring, particularly for early stage businesses and those preparing for, or seeking an exit. He has wide experience of advising on the impact and mitigation of direct taxes in the course of business transactions generally and those related matters as they impact on the owners and their key employees.