5 things you need to know about exit strategy, investors and tax before you enter the Dragons Den

There are many reasons for starting a company and although making money isn’t always at the top of the list, it’s definitely a big factor for most people. It might seem a long way off during the early days of operation, but having a clear vision from the outset of where your business is headed in the future and the desired exit strategy is essential.

If you are seeking external funding or investment backing from VCs, the final exit strategy will be an immediate focus for them too. And as the founder, you’ll want to ensure you receive the biggest financial rewards possible, which requires foresight and early planning, together with an understanding of what’s important to have in place.

Here are 5 things to be aware of from the outset to maximise the potential returns you can achieve:

1. Minimising tax when selling a business

The government wants to encourage enterprise and rewards entrepreneurs for the risks they take starting and growing a business, with tax relief on capital gains made when a business is sold in the form of entrepreneurs’ relief (ER).

Entrepreneurs’ relief appears at face value to have very simple qualifying criteria attached to it, but it is this apparent simplicity that can sometimes trip people up. To qualify for ER a business owner must hold at least 5% of the shares in the business, the shares must include full voting rights and be held for at least 12 months prior to a sale.

In return, qualifying entrepreneurs are entitled to a reduced capital gains tax rate of 10% (as opposed to the new main rate of 20%) when they sell the shares in their company. This is a lifetime tax relief to a maximum value of £10m and is available for each qualifying shareholder, so particularly beneficial for a family business to have access to.

2. HMRC approved share schemes can help build loyalty from staff and investors

One good way to motivate employees is by offering a HMRC approved share scheme, which allows them to benefit from the success of your company too. It also means you can attract some very desirable talent into your business without necessarily having to pay inflated salaries. There are various options, of which the EMI and ESS schemes are most popular for smaller companies. EMI is typically the more tax efficient, however not all companies will qualify in which case, ESS is a good alternative option.

Securing investment is equally important and there are many tax efficient schemes in operation to help small businesses secure growth finance. It’s important for a business to be as attractive to outside investors as possible and by seeking advance HMRC approval for schemes such as EIS and SEIS, business owners can assure would be investors that they will get full tax relief when they make an investment.

3. Invest in maintaining good statutory records

To keep costs down, many company directors are tempted to handle their company secretarial requirements in-house rather than use a professional. This may seem cost efficient in the short term, but can have an adverse impact in the future when the company is seeking an exit. This is because if full statutory records are not readily available, meetings fully minuted, and paperwork such as dividend vouchers properly prepared, purchasers can use these issues as an excuse to question whether they will be presented with other problems and either negotiate a reduced sales price, or request that a seller is liable for the cost of future tax liabilities should they arise post sale. It can become an expensive problem and therefore it’s wise to always ensure full company secretarial records are available at a glance, to be able to reassure would-be purchasers.

4. Beware of diluting your shareholding as a result of loans

Financial loans can originate from a number of sources and it is quite common for directors to initially informally source loan finance from friends and family, before turning to banks and investors once a business is more established. Where loans are already in place it is common for an investor to request that earlier, more ‘informal’ loans be converted into share capital. This gives the new lender greater control over how the finance they are providing will be utilised; for example, they may not want to provide finance to help a company grow, only to find it is then used to repay a previous loan.

Converting loans into share capital may have no particular implications at the time for the company, and the previous lenders may be happy to comply. It will however have the effect of altering percentage shareholdings across the entire company and could mean other shareholdings drop below the 5 per cent qualifying criteria for entrepreneurs’ relief to apply, without anyone realising the significance at the time. This situation can be avoided by being aware of the effects of a share dilution and using a company secretarial specialist to ensure the issue does not affect the main shareholders entitlement to entrepreneurs’ relief.

5. Beware the pitfalls of leaving a business too early

Over the many years it takes to grow a successful company, the founding directors and shareholders will inevitably face disagreements along the way. In some instances, these cannot be resolved, with the end result that one party leaves the company early, before their shares are sold and with some form of ‘post departure agreement’ for a share sale in place. This can also bring an end to the availability of entrepreneurs’ relief. The rule of thumb in these situations is never officially resign your officer or employee status, until after you have sold your shares.

If you would like to discuss exit strategy please conrtact Lesley Stalker by emailing las@rjp.co.uk