What could a Labour government mean for business sales?

In this white paper, Infinity Corporate Finance look at a white paper examining future government tax changes and how to prepare for them whilst Garfield Smith – Technology & Data Lawyers examine what steps entrepreneurs can take now in order to prepare for the sale of their business.

1.An increase in capital gains tax

The biggest consideration for selling entrepreneurs will be what could happen to capital gains tax; the tax that entrepreneurs pay when selling their business.

Currently entrepreneurs have a £1m Business Asset Disposal Relief (BADR) allowance where this first £1m is taxed at 10%. Beyond this amount the rate is 20% on the balance. This is far lower than dividend or income tax rates, meaning that the value of the business plus excess cash can be slow for this tax rate. With that in mind we often advise selling entrepreneurs to not pay dividends but to leave the cash in the bank and sell it to the buyer meaning it is taxed at 20%.

This tax rate is highly advantageous for entrepreneurs and is a factor for many looking to exit the business they have worked hard to build. However, even before a new Labour government there have been rumours for years that capital gains tax rates may increase to bring them more in line with income tax rates (i.e. up to 45%).

Prior to the Covid-19 pandemic there was a government review of the capital gains tax regime and in March 2021 the market was bracing itself for a rise in capital gains tax under the current Conservative Government. This resulted in many deals being completed shortly before the budget. Ultimately, there was no change but the rumours of a future increase have remained. With a change of government the chance of a change to capital gains tax rates is being brought sharply back into focus.

Labour have not made their position clear on this. Until they announce their first budget there will be uncertainty and the possibility of a rates increase. Whilst we cannot say whether a change is likely, we can explore what could happen over the next couple of years under a new Labour government.

If a rise is announced ahead of time (for example, an Autumn Budget in 2024 announcing a rise in capital gains tax for the new tax year in April 2025) entrepreneurs would be forced to accelerate their M&A sale processes. They would look to exit ahead of a deadline that, if missed, could cost them a significant amount of tax. By way of example and in very crude terms, someone with a £10m capital gain who still had their BADR allowance would pay £1.9m tax and have £8.1m net. Let’s just say the rate is doubled to 40%. In this situation the same capital gain, with BADR remaining, would have £3.7m tax, or £6.3m net. To look at it another way, to get the same net proceeds as the current rate the same entrepreneur would have to sell their business for £13m, a 30% increase in valuation.

When a rise is announced there will be an impact on valuations. Buyers will realise the tax impact of stalling and delaying on a deal for entrepreneurs, therefore putting them in a weaker position. This could be on valuation, or other terms, such as liability caps or indemnities. The need to sell becomes more imperative than the need to buy.

Imagine the conversation if the seller has had a poor couple of months’ trading. Usually everyone would delay the transaction for a period to see if the downturn was merely a blip. However, the seller needs to sell and the buyer knows this so reduces the price. As the seller your position is a lot weaker, you accept it, the deal falls over or you risk negotiating longer on it and incurring a bigger cost via tax.

There is also another impact. Even if a rise doesn’t materialise in the short term, if there are enough entrepreneurs concerned about a rate rise then there will be a flood of businesses looking to sell in the market. Like anything with value, the valuation of a business is impacted by supply and demand.

2.What can an entrepreneur do to prepare?

Entrepreneurs concerned about the potential tax implications that may be caused by a change of government can take practical steps now to ensure that they are able to move swiftly to secure an exit if that becomes the preferred course of action.

Such steps could include:

     

  • i.Determine what you are selling

Often the simplest way to exit a business is to divest the entire share capital of the company operating the business. However, this may not be practical if the vehicle in which the business to be divested resides contains other businesses, assets or liabilities which are not to be sold or are to be sold but to a different buyer.

Undertaking an audit of what contractually and legally sits inside the business will enable the entrepreneur to determine whether the business is sale ready. If it isn’t sale ready, this gives the entrepreneur time to either ‘clean up’ the business by undertaking a pre-sale reorganisation so that the business being sold only contains those assets, liabilities which are to be sold or for them to identify the assets and liabilities which will be sold by way of an asset sale (see also ‘Get an early start on due diligence’ at section iv. below).

     

  • ii.Do your homework on value

It is always a good idea to have an idea of what you think your business is worth prior to engaging with prospective purchasers. Accountants and tax advisers can be very helpful in this process (see ‘Identify your advisers and main points of contact’ at section vi. below). It is also worth bearing in mind that the consideration, the value you will receive for the sale of your business, does not just have to be cash on completion.

There are many different forms of consideration for the sale of a business. These can include cash but could also include a share for share exchange (in whole or in part), deferred consideration (in the form of shares or cash), earn outs or loan notes. More information can be found here. The different options will all have different tax consequences so again speaking to your appointed accountant/tax advisor is a must.

     

  • iii.Ascertain who needs to approve the sale

rrespective of the sale structure, third party consents may still be required to complete the sale. The aspect is usually undertaking in conjunction with due diligence (see ‘Get an Early Start on Due Diligence’ below).

Third party rights that need to be considered might include:

  • consent to the sale of the shares held by, and waiver of pre-emption rights vested in (depending on the articles of association), other shareholders where the entrepreneur does not own 100% of the shares;
    These shareholders may range from friends and family to VC/private equity houses and may well need to be managed in different ways. Circumnavigating these consents may be easier if the articles of association contain drag along rights which can be exercised. Accordingly, a careful examination of the articles of association of the business is advisable;
  • consent rights embedded in a shareholders’ agreement (such as majority investor consent rights which require a certain percentage of shareholders to consent to reserved matters which would typically include a sale of the business) which are more likely if third party investment has been accessed;
  • consent of board directors appointed by VC/private equity houses;
  • consents from major contract parties (suppliers, customers, and finance partners such as bank lenders) if their contracts contain change of control clauses; and
  • consents/approvals of regulatory bodies such as the Competition and Markets Authority or the government under the National Security and Investments Act 2021 (which gives the government powers to scrutinise and intervene in business transactions in order to safeguard national security).

A desktop audit of the businesses’ contractual and constitutional architecture to identify early on what consents/approvals might need to be obtained will enable the entrepreneur to anticipate how best to obtain those consents/approvals and the timeline required to achieve them. Forewarned is definitely forearmed!

     

  • iv.Get an early start on due diligence

Most buyers will wish to undertake (to a greater or lesser extent) legal, financial and accounting due diligence to enable them to assess the business they are buying and attribute a value to the business. Such due diligence will depend on the type of business being sold but will invariably cover areas such as corporate and commercial agreements, finance and accounts, tax, business assets, intellectual property, real estate, insurance, litigation and disputes, employees, pensions, employee share schemes, company policies (such as data protection, anti-bribery, etc), environment, health and safety.

Given the size and breadth of the areas to be covered, finding and collating the documents to produce a comprehensive and easily accessible data room for a buyer and its advisers to examine can be a time consuming process. The earlier the data room is compiled the better. In fact, all entrepreneurs should perhaps have in mind the data room when setting up their business; it is always amazing to find how many businesses do not have copies of their key contracts, those contracts are not signed, or they are not up to date with their filings at Companies House. A stitch in time here definitely saves nine when it comes to due diligence!

     

  • v.Line up your advisers

Even the sale of a relatively straightforward business can be time consuming and involve unexpected complications. For many entrepreneurs it can feel like another full time job especially if the sale is time pressured. Having the right advisers on board can save time and effort if their expertise is accessed early. It is , therefore, important to identify early who the entrepreneur’s legal, tax and accounting team will be and who, within the business being sold, will be the main point of contact through the sale process. Their desk may well need to be cleared of their other responsibilities.

     

  • vi.Start drafting the pre-acquisition agreements

Once interested buyers are identified there are legal agreements that need to be put in place as soon as possible. No meaningful discussions with a prospective buyer should commence in earnest without a confidentiality agreement in place to protect any information being disclosed about the target business including the fact that it is up for sale. Other legal arrangements that should also be considered before the parties start to draft and negotiate a sale and purchase agreement could include a term sheet (also known as a letter of intent) setting out the high level commercial terms of the sale and a lock-out agreement by which the prospective buyer is given a period of exclusivity to negotiate the purchase.

 

 

In summary, there is no certainty on what will happen this year in Westminster. Indeed, there is no certainty, if there is a new Labour government, how and when tax rates may change. However, for entrepreneurs looking to exit in the next few years it is certainly worth keeping an ear close to the ground. In any event, being prepared for an exit is definitely a good discipline, that knock-out offer could be just around the corner at any moment regardless of who has a majority in Parliament!

23 January 2024

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