We developed a business succession plan for two director-shareholders. They had founded their company, and, whilst retaining control, now wanted to pass equity over to junior directors as part of their retirement plan. However, the company had significant value. The directors wanted to avoid substantial tax liabilities.
New share classes
We reviewed the company’s existing articles of association. These arrangements were not tax efficient. The founders had split the voting rights and the rights to equity between A and B shares, which many years ago was a popular move.
We advised creating new share classes for the founders and the junior directors. These:
- Preserved the ability to claim entrepreneurs’ relief giving a 10% rate of capital gains tax when the company was eventually sold.
- Amalgamated the former A and B shares into one class of share for the founders.
Mitigating Inheritance Tax
The founders had insurance. This would provide the other shareholders with funds to buy the shares from the estate of the deceased founder.
We drafted a cross option arrangement in the shareholders agreement using wording which mitigated Inheritance Tax (IHT) liabilities for the estate. The wording also enabled the company to deduct its contributions from corporation tax.
Business succession plan
The company considered implementing EMI options for the younger directors. However, EMI options were inappropriate. The younger directors would not be eligible for dividend payments. This is because they would not be shareholders, but option holders.
We advised it was more tax efficient to issue new shares than to transfer existing shares to the younger directors. Issuing new shares meant that the founders were not liable to capital gains tax on the shares provided to the younger directors.
The different share classes ensured the founders could pay different rates of dividends. The founders also wanted the younger directors to concentrate on running the business without fear of interruption.
Hence we provided that on death the persons inheriting under the estate could retain the shares unless the cross option was initiated. However the shares would lose voting rights save for very important decisions.
We also provided a share capital table before dilution and post dilution to ensure the founders did not give away more than intended.
Shareholders agreement
The founders wanted to ensure the younger directors did not sell their shares to outsiders for five years. This would provide a lock-in, and security for the founders. We achieved this under a shareholder’s agreement, which set out, if any younger directors left, the:
- Order for sale;
- Price to be paid for the shares.
The price payable varied according to:
- How long the younger directors had been shareholders;
- Whether they left to join a competitor.
This deterrent helps safeguard the company’s intellectual property and customer base.
The shareholders agreement also included provisions to force the younger directors to sell their shares if the founders found a suitable buyer at the right price.
Control of the board
The founders wanted:
- To keep their hand in and guide the younger directors;
- But not be full time directors actively running the business.
We advised that the founder directors became non-executive directors, and step down from full-time involvement. The founders still had voting powers as directors, but not the daily obligations of full time directors.
We prepared non-executive director agreements, which:
- Set out their duties and obligations;
- Safeguarded their position;
- Minimised the risk of claims for breach of duty as a director;
- Defined the issues upon which founder approval was required thus giving them control over major decisions.
We drafted director service agreements for the younger directors. These agreements:
- Had clear reporting responsibilities;
- Included the power to suspend the directors if fraud or corruption was suspected;
- Gave the company the power to place the directors on garden leave, if notice of termination of employment had been served. This acted to preserve the post termination restrictions.
Implementation
We advised the company on the shareholder resolutions required to vary the classes of shares and implement new share rights. We also filed the appropriate documents at Companies House.
We also calculated the share valuation for when the younger directors received company shares. The valuation required HMRC approval, to determine the recipients’ income tax bill. We advised that the company loaned the younger directors the money to fund the income tax liability. We then drafted the loan agreements.