In the last few months, we’ve acted for a number of clients who are involved in a business with a ‘partner’ (that’s what they call them, but they are really a co-director and co-shareholder in a limited company) and one is looking to retire or exit.
In legal terms, this requires a transfer of shares from the seller. Usually, the seller wants payment – extraction of cash in the bank usually, but sometimes a share of asset value, goodwill etc. Whatever the commercial terms of the deal, there are two primary ways of achieving the end result:
- A company share buy back
- A personal share purchase
Let’s have a look at the two options.
Company Buyback of Shares
A company can buy back its own shares, and the Companies Act 2006 governs it. Limited companies must comply with Part 18 of the CA 2006 when purchasing their own shares and failure to do so will result in:
- The acquisition being void.
- An offence being committed by the company and every officer in default. An officer in default is liable to a prison term of up to two years or an unlimited fine, or both.
The company will need to execute a buyback agreement with the relevant selling shareholder(s) that must be approved by the company’s members either before the agreement is entered into or after it has been entered into but before any shares are repurchased.
Although the purchase price of buyback shares must be satisfied in cash in terms of the accounting entry on the other side of the balance sheet, a company can fund a buyback by any of the following means:
- From distributable profits
- From the proceeds of a fresh issue of shares made for the purpose of financing the buyback
- Out of capital
Most usually, is is from distributable reserves (i.e. cash in the bank).
There’s a number of considerations with a company buy back of shares:
- Do the company articles of association prohibit the buy back of shares? Do they restrict so called ‘financial assistance’?
- Do the articles of association or any shareholders agreement deal include pre-emption rights which need to be taken into account?
- Are the shares part of any employee share scheme?
- What price is going to be paid?
There is a legal requirement for the buy back agreement to be documented and approved. It will contain key terms such as:
- Name of selling shareholder(s).
- Number and class of shares being sold
- Price to be paid for the shares or a price range or formula to establish the price
The shares must be fully paid up and the purchase price must actually be paid on completion.
Once the shares are brought back, they will be cancelled by the company (leaving the remaining shareholders with 100% of the shares) and Companies House will need to be notified of the changes.
Personal Purchase of Seller’s Shares
The Company Buy Back route is generally a little more involved than a straight-forward purchase by one shareholder of another’s shares, and so where there are only two shareholders, it may just be easier and simpler to effect a share sale and purchase of the seller’s shares the buyer.
This need not be overly onerous and the share purchase agreement need not contain substantial warranties, a disclosure letter is not required and due diligence is unlikely.
The only major issue can be the funding of the purchase, because if it is ‘cash in the bank’ it is likely to require a dividend or loan paid to the buyer in order that the buyer has sufficient funds to pay the purchase monies to the seller.
In a sale of shares with a retiring shareholder, all we need is:
- A share purchase agreement
- Settlement agreement waiving any employment claims
- A resignation as director letter (and removal as PSC from companies house)
- Board minutes confirming the same
The process ought to be more simple, and in the world of lawyers, that usually means cheaper.
Which is better a share sale/purchase or a company buy back of shares?
The question is primarily one which your accountant or tax advisor should answer, as there is an impact on taxation.
However, on a costs basis, a share sale rather than a share buy back is likely to be more cost effective and quicker.
Are you thinking of retiring and looking to sell your shares to your other shareholders/directors? Or perhaps you’re considering a management buy in? Whatever it is you want to do, feel free to get in touch for your no obligation conversation about how Your Business Lawyer might help.