It is a normal question for the exiting shareholder to ask. In the call I had, it was different. It was more to do with the strategy of the business owner and what approach to take. We will look at options to exit your company:
- The stars
- The question
- One solution
- Another route
- Tony at 65
Playing the leading role is Tony [played by Brendan Gleeson], aged 56. A wily, clever Cavan man that still has his communion money. Tony’s son Mick [Chris Hemsworth] is 28 and works in the business with his dad. They sell laptops and servers and have 4 shops in Ireland. The company is TNT Ltd. Tony owns 75% of the company and Tom, Tony’s brother, [played by Aidan Gillen] owns the other 25%. The company has built up good cash reserves of €1,200,000.
Tony wants to pass his shares onto Mick. He has done his research and knows he will meet the conditions of Retirement relief, knows that he could get up to €750,000 if he exits the company now. He wants to get some shares to Mick as Mick has worked in the business for many years and has great ideas to drive it on. Tony likes working and he loves the security of having a weekly wage. He doesn’t have assets outside of the company. So, does Tony stay and continue working or does he go now? If he goes now, can he continue to draw a wage?
If Tony exits the company now a proper plan would need to be in place. A gift of some of his shares to Mick and then a share buyback may not work. The main thing here is to maintain the 75% ownership between Tony and Mick. A way around this is for Mick to set up a company to purchase Tony’s shares and secure bank finance to do so. He can refinance the bank loan from the cash that TNT Ltd has after buying the shares.
There is new anti-avoidance legislation in this space, so one must be careful.I stressed to Tony and Mick the importance of a company valuation here. A share transfer between father and son is a connected party transaction. Market value rules apply. Revenue will expect and may look for the valuation.
The valuation will determine the value of the gift of shares for Capital Gains Tax [CGT], Stamp Duty, and Gift Tax. They need to talk to Reg. See our previous blog on this here. If Tony exits via a share buyback that has to benefit the trade, to ensure CGT treatment. Revenue views an older director exiting, to make way for younger management, as a benefit of the trade. Their guidance states that the Director can stay on for a period of up to 6 months after the buyback. This would mean that after 6 months Tony’s couldn’t take a salary and should resign as a director.
If he continued to take a salary and remained as a director Revenue’s view is that there was no benefit to the trade. The benefit was to the director and the danger is that the payment is not liable to CGT but Income Tax. If Tony got €700,000 and that was liable to Income Tax at 52% that would be a tax liability for him of €364,000.
Tony stays and continues to work for the company. He gifts some of his shares to Mick and holds onto some, continues to take his normal salary. He likes the work but as he has no assets outside the company pension planning becomes important. So rather than reducing the cash reserves in one swoop, they decide to invest up to €700,000 in a pension for Tony. There is an initial lump-sum put in now, say €100,000, to get it going, and then the balance goes in over the next 9 years. The advantages of this are
- The cash reserves reduce by €100,000 now and not by €700,000
- Tony will have a pension asset at retirement of say €800,000
- The company will get a tax deduction of 12.5% on the payments
- Pension payments come from future retained profits, so the cash reserves position remains strong
- Assuming a pension pot of €800,000 Tony can get €200,000 of that as a tax-free lump-sum and €30,000 per annum. €600,000 at 5%
- Tony’s pensions [company and state] would be approximately €43,000. He could end up only paying 20% tax on this income.
The key here for Tony is that he will continue to earn his normal salary, so he has security of income.
Tony at 65
Tony still has some shares and needs help understanding his options. He wants to exit and get his remaining shares over to Mick. His options would include
- Gifting his remaining shares to Mick
- The company buys back his remaining shares
- Mick sets up a holding company to buy Tony’s remaining shares
If the company buys back his shares it is vital to meet the benefit of the trade test. Significant discounts apply to smaller percentage shareholdings. So, it makes sense for Tony to hold onto 25% of his shares or more. This will ensure that he can get Retirement relief at 65, provided he meets all the conditions then. For any of the 3 options above a company valuation will form the basis of the numbers. If going for option 2 you will need to be careful. Before a buyback let’s assume the position is
After a share buyback, TNT Ltd cancels Tony’s shares, so there are only 75 shares in issue
As you will see Tony and Mick’s family had 75% of the company before the buyback but after the buyback, they have 67%. This may not be an issue as Tom will be 61 then and is thinking of exiting too. He has got his little fingers in many other pies so is happy to do a buyback. After this happens Mick will own 100% of the company.
There is no perfect solution here. Tony’s desire to have the security of a salary was important to him. A possible solution, like a holding company, could ensure no dilution of ownership. The share sale by Tony to Mick, whether a one-off payment or via an earn-out is worth exploring further. This may kill two birds with one stone. Tony gets a payment for his shares that is liable to CGT and can continue to work.
A buyback now doesn’t work for future salary payments, as Tony would need to go within 6 months. While Tony was in favour of the “Should I stay option” these other options are worth exploring further.
Need help with a company valuation or passing on your business? Call Deirdre on 051396703 or start here. Tell us about you and your business and we will see if we can help.