Selling your company – the price
The price a seller gets for his company is usually at the top of his list of priorities. There are usually three ways of getting paid:-
The buyer pays cash for the shares.
The buyer pays all or part with its own shares.
The buyer gives the seller a loan note (an IOU) for all or part of the price.
It is sensible at the outset to agree how in principle the buyer is going to pay. There is little point in starting the sale process if this fundamental point has not been addressed. Professional advice early on regarding the sale structure, and most importantly the taxation implications for the seller, is sensible.
1. Buyer pays cash
The simplest scenario is for the buyer to pay the entire price on completion i.e. when the seller hands over the shares in the company. In this scenario the seller has no further involvement in the company. This is usually what sellers of small businesses imagine.
2. Shares in the buyer
In this scenario a company buyer issues shares to the seller for all or part of the price. The seller effectively keeps an indirect interest in the company he has sold. This can have tax advantages for the seller. It has risks as the seller may have difficulty selling the shares he has in the buying company and is likely to be a minority shareholder.
3. Buyer gives seller a loan note
In this scenario the buyer agrees to pay the seller later for some or all of the shares. The loan agreement is documented in a “loan note”. The buyer is effectively borrowing part of the price from the seller. The seller should take steps to ensure that he will be paid his loan. In small companies it will be sensible to obtain a personal guarantee from the directors of the buying company. The seller should check the buyer’s creditworthiness carefully and think about asking for security in the form of a charge over the buyer’s assets. The terms of the loan such as when the seller is to be paid and the rate of interest are set out in the loan note.
The price may not be paid in full. Often some money may be held back by the buyer as a retention. The share sale agreement may provide that if there is any breach of the agreement the buyer can obtain compensation from the retained money. Breaches could include warranties that the company has paid all its taxes. There is usually a cut-off date (say 1 year after completion) after which the retention must be paid to the seller. The share sale agreement may specify that only claims over say £10,000 apply to stop buyers making lists of small claims. The retention money may simply be held by the buyer or by a third party such as a solicitor as an escrow agent.
These are quite common. The seller is paid according to an agreed formula, such as a multiple of the businesses turnover in the following year or an average of profits over the next three years. This can be attractive to a buyer as it ensures the seller stays motivated and with the business for some time after the purchase. For a seller it is more problematic as actions the buyer takes may frustrate the seller in achieving the buyout target.
Some earn-outs will provide for payments to be made every year. So if the earn-out depends on the profits of the company over three years payments may be made on an interim basis at the end of year one and two with a final adjusted payment at the end of year three.
For earn-outs to work the seller has to be prepared to carry on working for the buyer usually as an employee under the buyer’s control. For many sellers this is unattractive and a lot will depend upon the relationship after the sale.
Solicitor-Advocate and Chartered Tax Adviser