Buy-out of 50% shareholder

Discussion in 'Accounts & Finance' started by Mylo, Jul 11, 2010.

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  1. Mylo

    Mylo UKBF Newcomer Free Member

    24 1
    Hi All,

    Been reading this forum for a while, and now after some help. Any advice would be greatly appreciated.

    4 years ago, myself and a friend set up an IT consultancy company. My friend is really just useful for the office administration, while it is me that deals with clients and brings in new consultancy business. He has indicated that he now wants to exit the business (he is at retirement age). Our accountant has valued our business at £300k. This is heavily discounted based on the fact that only so much value can be attributed to rolling IT contracts. That said, I am confident of maintaining relationships and further expanding the business.

    Given that he wants out, it's fair to say that he doesn't really add value. But he has indicated that he reckons the business is worth closer to £500k given the size of some of the contracts that we have. Our turnover is about £700k with net profit of £90k. We take most of the annual profit via dividend (i think that's how the accountant does it anyway).

    Regardless of this, there is about £50k cash in the business at the moment. I want to offer my partner £150k for his 50% shareholding. My accountant has advised that it should be the company that buys back the shares, for whatever reason. Thing is, the company will need to borrow £100k+ to do the buy-back. But the net asset position of the balance sheet is only £35k. I would have thought that taking this loan would make the net asset position negative, but i'm not really that sure of how these things work. My accountant has been reasonably helpful, but i'd like to get some impartial views before proceeding. The accountant has stated that he doesn't think, given the cash inflows of the business, that borrowing the money will be a challenge.

    Basically, i'm wondering what people's views are on how I should proceed and whether what i have stated seems reasonable. I'd also be interested in any comments on what the accounting entries would be for the various bits of this transaction.

    Thanks in advance.
    Posted: Jul 11, 2010 By: Mylo Member since: Jul 11, 2010
  2. Chris Ashdown

    Chris Ashdown UKBF Legend Free Member

    10,331 2,097
    Turnover is unimportant its net profit that counts.

    There are many ways to value a business, but a large number are valued at between say 3-6 times net profit

    If he leaves does that effect the company in a bad way are sales likely to be down next year if so that could be taken into account
    Posted: Jul 11, 2010 By: Chris Ashdown Member since: Dec 7, 2003
  3. Mylo

    Mylo UKBF Newcomer Free Member

    24 1
    Hi Chris,

    Agree profit is important figure. Regardless, i'm only willing to pay £150k. If he isn't happy with that, then I'll have to look at winding that company down, and maybe starting something new in my name only. he understands, and is ok with this. I think he'll accept the £150k.

    To be honest, his leaving is going to save the company money. he doesn't contribute to the company any more, only really being involved in the initial setup of systems etc of the company.

    Posted: Jul 11, 2010 By: Mylo Member since: Jul 11, 2010
  4. weweavewebs

    weweavewebs UKBF Contributor Free Member

    32 2
    I think there are only 2 options. The company can borrow the money to buy his share or you can put money in the company yourself, latter is a better option if you can afford to do that as it will save the company paying interest.
    Last edited: Jul 12, 2010
    Posted: Jul 12, 2010 By: weweavewebs Member since: May 28, 2010
  5. Mylo

    Mylo UKBF Newcomer Free Member

    24 1
    Hi, would have to be the company doing to borrowing. Simply isn't an option for me. What would be the accounting entries, and its effects on my balance sheet?
    Posted: Jul 12, 2010 By: Mylo Member since: Jul 11, 2010
  6. Rolo Tomasi

    Rolo Tomasi UKBF Regular Free Member

    150 33
    For the company to buy back the shares it must have sufficient retained profits to do so (ie the balance of the P&L reserve must be more than £150k). Is this the case?
    Posted: Jul 12, 2010 By: Rolo Tomasi Member since: Nov 19, 2009
  7. jim_price

    jim_price UKBF Regular Free Member

    456 100
    In response to the previous message, a private company can make payments above and beyond the level of retained profits, that excess being termed a Permissible Capital Payment (PCP). There are a couple of hoops to jump through, for example directors are required to give solvency statements to creditors.

    Other formalities will include checking the company's Articles of Association to ensure Company Purchase of Own Shares (CPOS) is permitted. One point to consider is the tax treatment of the payment to the vendor. If he had held the shares for 5 years he would be eligible (assuming other criteria met) for capital treatment and an effective tax rate of 10%, if it's less than 5 years it will be taxed as an income distribution (i.e. dividend) with an effective rate of somewhere north of 25%. When will the 5 year holding period be achieved? Could you agree terms now with a view to completing on the 5 year anniversary date?

    I think your accountant is steering you in the right direction but I would ask him to explain the steps in detail so that you are comfortable with the process. If he doesn't mention the PCP rules then I would be a little concerned. Feel free to PM me with any questions.
    Posted: Jul 12, 2010 By: jim_price Member since: Aug 25, 2009
  8. Mylo

    Mylo UKBF Newcomer Free Member

    24 1
    Thanks for all input guys. P&L reserve is circa £50k, as we take most of profit out as dividend. This PCP sounds interesting and will certainly be something I ask my accountant about.

    With regard to the 5 year holding period, this is still slightly over a year away, and probably not something either of us want to defer. that said, if I could get him to take £50k now, I guess that keeps me within borrowing criteria as far as the retained earnings go. Following which, I can agree to pay him the remainder over a fixed term...
    Posted: Jul 12, 2010 By: Mylo Member since: Jul 11, 2010
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