When shareholders in private companies are retiring, the obvious route that the remaining shareholders in the business consider taking is for the company to buy that person’s shares. It appears to avoid the other shareholders having to buy the shares, so it seems like a neat way of doing it.
However – it’s not that easy. If it isn’t done correctly, it’s illegal, and it’s a criminal offence, as well as being void. This is covered by Part 18 of the Companies Act 2006. Bedtime reading – I’d not recommend it.
There is a minimum level at which the company can buy its own shares if its articles permit it – at the lowest of £15,000 or 5% of its nominal share value. That only covers very small transactions.
Otherwise, the company has to have sufficient distributable profits, and purchase out of those profits, or buy out of capital. Purchases out of capital are rare, because the procedure involves public advertisement of the procedure; and because that could alert and alarm creditors, it is not favoured and it’s largely avoids.
Buying from profits, though, involves more than declaring that you’ve got profits. Last week, where a client of mine has shares doe to bought, the company’s solicitor sent me a copy of the accounts to try to fob me off on this test. It seemed to me that he didn’t understand the process or the rules. From a non-accountant view the profits looked like they were less than the buyout, in any case; but I would require the company’s accountants to certify that there were sufficient distributable profits.
The other issue, which I’ve written about before, is over deferred payments – a company can’t contract to buy out shares in the future – there has to be a buyback agreement, and the shares have to be bought back immediately. Otherwise, there would have to be a series of contracts, and the legal tests would have to be passed on each contract. This then involves buying under a series of tranches. From the seller’s point of view, there may be tax disadvantages to this because the later tranches could be exempt from Entrepreneurs Relief. You’d need tax advice on this.
Another approach to this, which is also technical and not dealt with here, is through the creating on a new holding company to buy the shares. We’d always work closely with accountants on anything of this sort, and they would apply for clearance from HMRC – to demonstrate that the structuring is for a bona fide commercial reason and not for tax avoidance.
This is a common issue, and the solution often isn’t as straightforward as it may seem. In the case that I mentioned, the lawyer seems to have no understanding of the issues which apply, and like so much law – it isn’t something for people, even lawyers, to be dabbling in.