When advising vendors on a transaction, a challenge that commonly arises from a tax perspective is related to the structure of the management rollover or reinvestment of equity into either the purchasing business, or a Newco set up to execute the transaction.
This is relevant across a wide range of sectors that we advise on from a shareholder transaction perspective, but it often crops up in the financial services sector specifically.
The structure of the deal can significantly impact the financial outcome for the vendors.
Background
Recent transactions in the financial services sector, whereby we have advised the vendors on the sale of a majority stake in their business to third parties, have changed quite considerably in structure throughout the process.
The initial offers from the purchasers frequently comprised multiple elements of consideration for the vendors, for example cash on completion, earn-outs, deferred cash consideration and equity in the purchaser.
The equity in the purchaser can often be structured as cash payments at completion, with the vendors then being required to reinvest in ordinary shares, preference shares and/or loan notes in the purchaser.
The various forms of consideration provide several tax issues for the vendors that need to be managed carefully.
This is to ensure that any tax liabilities that arise on the disposals are aligned with the timing of the cash being received by the vendors.
Equity roll up rather than reinvestment
The purchaser equity element, when structured as a reinvestment using their cash completion payment, has specific capital gains tax implications.
It results in the entire consideration being taxable for the vendors in the year of disposal, leading to a tax charge in excess of cash received and a cash flow issue for them.
For a transaction which completed in the 2023/24 tax year, the associated capital gains tax would be payable by January 31 2025.
However, with a complex consideration structure, in many cases the vendors would only have received a small amount of cash on completion relative to the value of the transaction, which was subject to tax on completion.
A better approach is therefore to structure the transaction so that vendors exchange their current shares for shares or securities in the purchasing business.
To take a simple example, imagine a vendor receives total consideration on a transaction of £5m; split £1m in cash on completion and £4m worth of equity in the buyer structured as a reinvestment.
The vendor would pay CGT on the total proceeds of £5m, resulting in tax of £1m payable by January 31 in the year following the tax year of completion.
After taking into account various transaction deal fees, the vendor is actually at a cash flow disadvantage as the entirety of the proceeds which they received in cash are required to pay the CGT bill.
Conversely, if a share exchange structure is implemented the vendor would be subject to CGT only on the cash element of the proceeds received.
