In small private businesses, the distinction between ownership and control is often blurred as the Directors and Shareholders are usually the same persons. However, the roles are different so the implications on retirement do vary. In family businesses, the issue of succession of ownership and control can be even more complicated.
But to start with, here are the basics…..
Control (as Director)
Directors have a fiduciary duty to manage the business and act in the best interests of the company and its Shareholders. Directors are employees, where the job description and remuneration terms may be outlined in an employment contract. Provision for Directors on retirement may be set out in the pension plan arrangements in place.
Ownership (as Shareholder)
Shareholders own the business, and as investors, they do not participate in the day-to-day running of the company. The appendix below summarises different types of share class. In private companies, it is good practice for a Shareholder Agreement to be in place.
So when Directors retire, what do they do with their shares?
Before seeking professional advice, take a look at the crib sheet below of the key issues.
1) For the company, what are key objectives and priorities?
a. Who will manage the business going forward? Is it better to consolidate control in fewer Directors or diversify by appointing new Directors?
b. Who will own the business in future?
c. What is the balance sheet and cash flow position?
d. Is there an impact on creditors? For example, are there Personal Guarantees in place from Shareholders?
e. Are there plans for future expansion, family inheritance, a private sale of the business or ambitions to go public?
2) For the individual, what are the reasons behind any transfer of share ownership?
a. Do new Directors need share incentives as part of their remuneration package?
b. Does the existing Shareholder need the capital back to invest elsewhere? Or does he/she want to continue receiving the dividend income to top up his/her pension?
If the decision is to retire AND transfer ownership, then keep the following information in mind to discuss with professional advisors.
3) Check the Shareholder Transfer Provisions, in Articles and/or Shareholder Agreement for:
a. Gift or sale of shares to a family member
b. Sale of shares to a 3rd Party investor
c. A request the Company to buy-back shares using distributable profits
4) Work out the procedure for transfer of shares, such as:
a. Mechanism for valuation for the company, set out in Articles and/or Shareholder Agreement.
b. For fairness and transparency, an independent firm can do a valuation of private company shares.
c. Heads of Terms, due diligence, warranties and indemnities, and Share Purchase Agreement
d. Duties of Company Secretary to arrange board resolutions, inform Companies House and HMRC clearance (where applicable)
5) Tax implications for the individuals involved, such as:
a. Stamp Duty
b. Capital Gains Tax (NB:Entrepreneur’s Relief and any other reliefs)
c. Income Tax
d. Inheritance Tax planning
Often, just working out where to start can be difficult so the above is intended as a guide to planning. If you would like any help, please get in touch.
APPENDIX: Types of Share Class
• Ordinary Shares:
o Voting vs Non-Voting
o Fully Paid vs Nil or Partly paid
o Deferred: where no dividend paid until other classes of shares have received a minimum dividend
o Alphabet Shares: for example, where A have all voting rights, B have all dividend rights and C have all capital rights.
• Preference Shares:
o Pays a fixed dividend each year (%) fi the company has profits to pay
o Ranks above ordinary shares so the preference dividend is paid before ordinary dividends
o Cumulative vs Non-Cumulative (if insufficient profits in one year to pay fixed dividend)
o Do not normally carry voting rights
• Redeemable Shares: (Usually Preference shares)
o Company can only issue redeemable shares when there is a minimum of one non-redeemable share in a different class (eg ordinary shares in issue already)
o Company has the right or obligation to buy back the shares at a future date, which can be similar to a loan where the company pays a fixed interest rate until a certain date and then repays the capital amount
• Convertible Securities: Preference Shares or Loan Notes (for publicly traded companies)
o Receive fixed interest until price reaches a level where it converts to ordinary share