If you are an owner-managed business but want to maximize sales revenue at completion (and avoid an earn-out structure), you will need to have a new management team in place before you leave to demonstrate to the buyer that this is not the case is. You do not need to remain in the company to perform management or sales functions to maintain profitability upon completion.
But what kind of compensation package should you offer to hire and incentivize a management team before leaving the company?
Part of such a package is, of course, offering competitive salaries, which could have a negative impact on the company's earnings before interest, taxes, depreciation and amortization (EBITDA) if, as is the case with many companies, the salary of the owner prior to a sale was modest, with a supplement in the form of dividends on shares.
A second element is to offer some form of equity incentive. This can be in the form of shares, options or phantom equity.
“Phantom equity” means little more than a cash bonus payment by the company or seller to the manager, depending on the level of sales proceeds achieved on an exit, and is tax inefficient as it will be subject to income tax and national insurance.
On the other hand, if you issue shares to management, they can benefit from dividends prior to a sale and a capital gain upon sale. If structured correctly, issuing shares can be more tax efficient than phantom equity. But since you are issuing actual shares, you should consider including provisions in a shareholders' agreement or the company's articles of association to ensure: (i) that voting rights attached to management shares are not sufficient to disrupt your day-to-day management of the company, (ii) that you can easily get back or lose the shares if a manager leaves or is fired before an exit, with appropriate valuation and vesting provisions for good, bad and interim departures and (iii) that at the exit itself you can also you can ensure that managers sell their shares together with you, usually by building in a 'drag-along right'.
It is important to seek tax advice so that the shares are not seen as emoluments and are subject to PAYE and National Insurance (which can be difficult) and the manager who receives them will avoid the potential future Capital Gains Tax (CGT) (or income tax) must understand. ) debts.
Under current rules, CGT is payable on a sale of shares at 20% unless (among other conditions) they have been held for 24 months, where they may qualify for business asset relief and a 10% tax rate on the first £1m gain.
An alternative to issuing shares is to grant options under an Enterprise Management Incentives Scheme (EMI) which is available to companies that meet certain criteria including (non-exhaustive) – gross assets of £30 million or less, less than 250 full-time employees, employees working at least 25 hours per week and a maximum of shares worth £250,000 can be awarded to each individual.
The advantages of EMI options over issuing shares include the following: (i) that options can be written so that they are exercisable only on an exit and expire if a manager leaves before an exit without the need for the shares to be physically transferred or forfeited (ii) that management need not pay for their shares until a cashless exercise upon exit, where the sale proceeds are available to fund that payment, and (iii) that there should be no risk to the company in voting by managers or trading with minority shareholders.
You will of course need to give the new management team time in advance of any proposed exit, not only to take over the day-to-day running of the company, but also to demonstrate that it is as reliable and profitable under their leadership as before. under your own daily control. How long this period will be will depend on the nature of the business and the idiosyncrasies of the intended buyer, but could be as long as 1-2 years to enable the buyer to see a track record of success under the new management team to to reassure the buyer. that the team is capable.
As always, before planning an exit from a company, give yourself time to think about the outcome you want to achieve and devise the best strategy to help achieve that.
