Buying out a business partner

[trickywoo]

Hi All,

Wonder if anyone can assist from personal experience or professional knowledge?

I am in a Limited Company with a business partner 60/40 in my favour. The 40% holder is coming up to retirement and wants to sell.

A value of their shares has been agreed at £20,000. No problem with this.

Problem is they are asking me to buy their share including current assets (mainly cash in bank). This puts their 40% value at approximately £40,000 in total. Their rationale for this is that they will benefit from the 10% Entrepreneurs' Relief and not have to pay income tax on the dividends that would be paid normally out of the cash.

The problem for me as I understand it (could be wrong) is that if I pay their share of the cash in bank when I eventually take it out of the business I will pay normal income tax rates. I.e. I will essentially be paying this proportion of income tax for them.

Doesn't seem fair.

Being 60% I am under no obligation to do this and they are making noises about being above board and fair so what is the best way of going about this?

Thanks

[Eric Mc]

How did they arrive at a value of £20,000 for the shares? If they want £60,000 from you to buy his shares, isn't THAT what the value must be?

[trickywoo]

Eric Mc said:

How did they arrive at a value of £20,000 for the shares? If they want £60,000 from you to buy his shares, isn't THAT what the value must be?

Indeed. However, we've received an offer equating to this amount from another company so I feel morally obliged to match it. I took a bit of a gamble with offering the business for sale in order to arrive at a figure that 40% couldn't easily dispute. They had previously valued it much higher so in some ways it has worked for me.

Just for clarity there isn't loads of money in this and paying the buyout amount will affect me for quite a while. I view the company as being worth much less as its just the two of us generating income but having not been able to arrive at an acceptable buyout figure before this it is an improvement.

I believe I could close the company and start again but £20,000 to maintain morals seems OK.

[illmonkey]

Surley sell it, both profit and start a new one up?

[trickywoo]

illmonkey said:

Surley sell it, both profit and start a new one up?

Sell out is subject to us working for them on less attractive terms than if it continues as is.

The other problem is that the potential buying company may just do it themselves and we have another competitor. As ever nothing is simple but suffice to say for £20,000 I'm willing to gamble that I can make it work better than alternatives that are available to me.

[akirk]

the external offer values the overall business at £50,000
- is that excluding cash & other assets?

the important thing to note though is that it includes both of you working in the business after sale...
i.e. the valuation is based on acquiring the two income generators...
arguably therefore the share value of the business is in the two people - not in anything else, or majority of value in the two people...

by his leaving the business he is reducing the income generation of the business - the value of the business that is left is simply your ability to generate income... therefore he is taking his value out of the business by leaving (he could start up again and then he has that part of the value in his new business)

i.e. I would doubt if there is an intrinsic valuation to the business without the two of you (would the external buyer have offered the same purchase without either of you continuing to work for the company?)

so valuation on his shares = £0

split the assets (though you don't need to - they are the business' assets to continue the business, not the shareholders' assets - if you come up to retirement and sell your shares in BT, while the value of the shares might have a reflection of the assets in BT, you don't get to chose to take 'your share' of the cash BT has in the bank!

Based on what you are saying - his request is on the (considerable) high side!

[Frimley111R]

trickywoo said:

Indeed. However, we've received an offer equating to this amount from another company so I feel morally obliged to match it.

But what is his alternative, he can't sell his 40% to them. That's effectively impossible (as buyers don't want to buy percentages like this in small companies). It's also much easier to sell out to you too. Who knows if the other company will knock the pice down, be challenging to deal with etc.

[trickywoo]

akirk said:

the external offer values the overall business at £50,000
- is that excluding cash & other assets?

the important thing to note though is that it includes both of you working in the business after sale...
i.e. the valuation is based on acquiring the two income generators...
arguably therefore the share value of the business is in the two people - not in anything else, or majority of value in the two people...

by his leaving the business he is reducing the income generation of the business - the value of the business that is left is simply your ability to generate income... therefore he is taking his value out of the business by leaving (he could start up again and then he has that part of the value in his new business)

i.e. I would doubt if there is an intrinsic valuation to the business without the two of you (would the external buyer have offered the same purchase without either of you continuing to work for the company?)

so valuation on his shares = £0

split the assets (though you don't need to - they are the business' assets to continue the business, not the shareholders' assets - if you come up to retirement and sell your shares in BT, while the value of the shares might have a reflection of the assets in BT, you don't get to chose to take 'your share' of the cash BT has in the bank!

Based on what you are saying - his request is on the (considerable) high side!

I agree with all of this. However, 40% wants to cash out and seems happy to make my life difficult if they don't. They are 70 years old and on the slow down. Arguably as the majority of the income is dividend related and they are taking 40% I am carrying them already and have been for some time. They absolutely refuse to see the situation as you have described and I and many other people I have spoken to see it.

In offering the business for sale to a third party I hoped they would make a very low offer and confront 40% with the reality of its value. They offered £50k in total for the right to carry on the business, no assets were included in this but cash in bank is our only real asset. I know 40% is technically worth less than the straight ratio and no way would the other company buy just this but I still feel morally obliged to pay £20,000.

The best way of doing this and sorting out the cash is my main concern.

[trickywoo]

Frimley111R said:

But what is his alternative, he can't sell his 40% to them. That's effectively impossible (as buyers don't want to buy percentages like this in small companies). It's also much easier to sell out to you too. Who knows if the other company will knock the pice down, be challenging to deal with etc.

40% has been difficult throughout. I think my options are pay £20k. Close the business. Sell to third party. Carry on as is.

Paying £20k is the lesser of two weevils. They are likely costing me more than this a year in dividends they haven't done the work to earn.

[Frimley111R]

trickywoo said:

Paying £20k is the lesser of two weevils. They are likely costing me more than this a year in dividends they haven't done the work to earn.

Sounds like a no brainer tbh. In 1 year you'll be where you would be if he stayed.

[srebbe64]

Is the £20k simply 40% of what you were offered? Usually a minority shareholding would be discounted by up to 70%. Do you have a shareholders agreement in place? Also I imagine you're the only person who would want to buy his shareholding - so you hold the all the aces really. Just tell him what you're prepared to pay. Full stop.

[Ean218]

trickywoo said:

They are likely costing me more than this a year in dividends they haven't done the work to earn.

Dividends aren't paid for work, they are the return on capital.

If the shares are paying more than 20k every year in divis then they are worth considerably more than that themselves. Think how much capital you would need to earn 20k pa interest at a bank!

[trickywoo]

Ean218 said:

Dividends aren't paid for work.

They are if you are powerfully built working in a two man and a dog Ltd.

[Ean218]

trickywoo said:

They are if you are powerfully built working in a two man and a dog Ltd.

You'd better not tell HMRC that.

[trickywoo]

Ean218 said:

You'd better not tell HMRC that.

Its perfectly legal and sometime after the 6th April each year I tell them in detail as do thousands of other people in the same situation.

[Eric Mc]

It's not a "legal" dividend if it is your remuneration for the work you do in the company. If that is what the payment is really for, then you are submitting incorrect Self Assessment tax returns and paying incorrect Income Tax and National Insurance amounts.

[trickywoo]

Eric Mc said:

It's not a "legal" dividend if it is your remuneration for the work you do in the company. If that is what the payment is really for, then you are submitting incorrect Self Assessment tax returns and paying incorrect Income Tax and National Insurance amounts.

Is there much case law on such a scenario Eric?

[Eric Mc]

There is plenty of case law regarding certain elements of this - often related to "personal service" companies (usually IR35 related).

The fact that people are less than honest about the nature of the payments they receive from their own companies is well known to HMRC. However, HMRC has limited resources so depends on companies and their directors being truthful.

[sideways sid]

Suppose you were thinking of taking early retirement; ask 40% what he would buy your shares for. Whatever number he provides, will give insight to his thinking.

If he values your share optimistically, ask him to justify it. If he provides a low number, turn it around and offer him two-thirds for his shares.

[trickywoo]

sideways sid said:

Suppose you were thinking of taking early retirement; ask 40% what he would buy your shares for. Whatever number he provides, will give insight to his thinking.

If he values your share optimistically, ask him to justify it. If he provides a low number, turn it around and offer him two-thirds for his shares.

I've tried this angle too only to be met with 'why would I buy your shares I'm retiring'.

There really is no reasoning to be done unfortunately. At least I have a figure that someone else will pay as a guide.

I would of course like to pay much less and believe the value is much nearer nil than £20k but if I want to continue (without ill feeling and possible consequent outside business issues) its the price I'll need to pay.

Doesn't look like anyone here will actually help with the best way of paying it though