Restructuring your Business for a Sale
April 30, 2010
Selling a business can be difficult, especially in the current market. As investors keep a tighter grip on their purse-strings, it is more important than ever to present the potential buyer with as attractive a proposition as possible. However, it may well be that the existing corporate structure makes a purchase less inviting or simply makes the sale more complicated, time-consuming and expensive. Buyers are keen on reorganisations which split off the business unit they are interested in purchasing, since buying part of a company can lead to uncertainty as to exactly what it is the purchaser is getting. Group structures often develop organically, in response to acquisitions or for purposes subsequently abandoned. It is not uncommon to have intermediate holding companies which add nothing to the business, or to have companies duplicating one another’s services within the group.
These factors can make a group somewhat confusing to outsiders and, often, the wise thing to do is to reorganise a group before actively marketing it. This may involve splitting off business streams or packaging together connected assets into self-contained units ready for sale.
Other drivers for a restructuring include a desire to relieve part of a business from regulatory burdens, allowing different business streams to pursue different funding strategies, or simply to give existing owners a clearer picture of operations. Restructurings undertaken for reasons other than a sale should nonetheless be carried out with an eye to how a potential purchaser may view the restructured group, as this is a useful tool to assess whether the restructuring is adding real value.
Once a commercial decision has been taken to restructure, there are several routes by which a restructuring can be achieved. The two main options are a statutory demerger and a reconstruction under the Insolvency Act (using the Insolvency Act procedure is, somewhat confusingly, not an indication that the Company is insolvent!). Each has its advantages and disadvantages, and their different tax consequences must be borne in mind when considering which route to take.
Statutory demergers are generally of two types: direct and indirect.
In a direct dividend demerger, a parent company declares a dividend which it satisfies by issuing shares in the subsidiary it wishes to demerge. This transforms a group of one parent and one subsidiary into two separate companies, both of which are owned by the shareholders of the original parent company. A clear advantage of this is that it is relatively straightforward, and requires only ordinary resolution approval in general meeting. An indirect dividend (also known as three-cornered) demerger is another possibility. Here, a dividend is declared and then satisfied by issuing shares in the demerging subsidiary to a new company. This new company then issues shares to the original parent company’s shareholders. This mechanism allows groups comprised of a parent with a number of subsidiaries to be reorganised as a number of smaller groups all of which are owned by the shareholders of the original parent company. This is a more complex structure, as another company is needed and a distribution agreement must be reached with the shareholders. The indirect method traditionally had an advantage over direct dividend demergers as it could qualify as a scheme of reconstruction for tax relief. Now, however, the Substantial Shareholding Exemption ('SSE') may be available in both, such that no corporation tax would be payable on capital gains by the parent company if broadly, the demerging subsidiary is a trading company and the parent’s share is 10% or more.
Both kinds of demerger have potential pitfalls. In order to carry out a direct dividend demerger certain preconditions must be met, including requirements that the parent company has sufficient distributable reserves available to cover the value of the shares’ disposition. Unless strict conditions are met, the parent company might find itself liable for increased corporation tax through any gain made on the transfer. Furthermore, the shareholders will face income tax payable on the dividend received unless the dividend is treated as an exempt distribution. This treatment is available where, for example, the demerging subsidiary is a trading company and there is a trading benefit through the demerger. Furthermore, if any of the companies involved is sold or effects a share buy-back within five years of the demerger then tax on ‘chargeable payments’ made within that time can be payable. It is possible to get advance clearance from HMRC, but this can delay matters in blocks of 30 days at a time while the application is examined. Despite these hurdles, a statutory demerger can be the right choice for many businesses.
Section 110 Procedure
An alternative to the above statutory demerger options is a reorganisation under section 110 of the Insolvency Act. Under this procedure assets are usually concentrated in a parent company, which is then (voluntarily) liquidated and the assets transferred by the liquidator to two or more new companies. In consideration of this, the new companies issue shares to the original parent company’s shareholders in satisfaction of their rights on winding-up. Thus one company (or, indeed many companies within a group) with several different business operations can become several specialised, more saleable companies.
The procedure necessary for a s.110 reorganisation is somewhat more convoluted than a statutory demerger and the procedure perhaps suits larger more disparate groups. A key difference is that a third party liquidator must be engaged to arrange the asset transfers out of the parent company. In addition, a special resolution is required from the shareholders to effect the winding-up and the directors must swear a statutory declaration of solvency. There are additional statutory procedures to follow to make sure creditors do not object, as the parent company will be liquidated at the end of the process, making it more difficult for creditors to bring claims. These issues make the process more lengthy than a direct dividend demerger and, particularly if there are creditor issues, make it a less predictable method.
The key advantage, however, is that s.110 does not require distributable reserves (except to the extent necessary to get assets into the parent company to be liquidated), which may rule out the statutory demerger process.
Section 110 also offers tax advantages. As the process involves a winding-up, neither the transferee companies nor the shareholders will attract income tax in relation to the distribution of assets from the liquidated parent company. The SSE can also apply, broadly, as long as the parent is disposing of 10% holdings in trading subsidiaries. If the arrangement also meets the criteria for a scheme of reconstruction then the shareholder’s new shares should be exempt from capital gains tax (as is true of the statutory demergers). However, the winding-up parent company may prove unable to avoid a degrouping charge if any of the assets being transferred came to the company from within the group in the last six years. If the intention is to split one company into several smaller ones, this will not be an issue.
Although there are clearly a great many logistical and legal issues to be considered when effecting a demerger, these should not discourage business owners from undertaking an exercise which can have a very positive effect on a business, not least offering the potential to attract buyers and to obtain the best price. If there is a commercial imperative to reorganise a company or group, then the question should not be whether a reorganisation should take place, but when.