How To Buy Out a Director

In the world of MBO/MBI transactions, perhaps the most common is that of an internal employee or shareholder buying the ownership stake from an existing director. The reasons for a buyout can vary, but common scenarios include:

• An owner is approaching retirement and wants to fund their post-work lifestyle
• The owner has lost interest in the business and wants to move on
• The owner wants to give control to a younger team with different ideas. They may still retain some shares but give up their controlling stake. 
• Diverging views between directors cause conflict, and one or multiple directors decide to buy the other out. 

The main differentiator here is whether the buyout is mutually agreed and amicable or the result of a dispute. Each scenario will necessitate a different approach from the buyer and seller, which we’ll cover later in this guide. 

Regardless of which scenario leads to the buyout, the desired outcome is the same: the director leaves the business and is fairly compensated in exchange for their stake in the business. In most cases, this can be valued by the share capital held by the director against the total value of the business.

The sale is typically structured around the cash price of the director’s shares after valuation, which may be a significant sum. Buyers generally need financial support from banks or other lenders to make the purchase – but the terms and rates offered will depend on your application and the nature of the buyout. 

Rangewell helps teams and individuals who want to purchase a departing director’s stake. We’ll not only guide you through the lending process and negotiate the deal on your behalf, but we can also provide access to professional valuers, accountants, legal professionals and more to make the process as straightforward and stress-free as possible. 

How to value a business for a buyout

Businesses often have rough valuations performed by their own financial teams or affiliated accountants. These valuations are typically taken as a calculation from operating revenue and profits. When buying a director out, any prior valuation must be ignored in favour of an independent valuation.

Generally, a true objective valuation comes from analysing your business’s EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). The valuation should account for the future by exploring questions such as if the selling director’s exit will impact profitability. 

Having an independent valuation allows the seller and buyer to agree on a price for their portion of the business. Relying on outdated or internal valuations may lead to a seller demanding a higher price than they deserve or another conflict. It’s important to keep communication moving in a positive direction to secure the future of the business. 

Understand the business structure ahead of the sale

The actual structure of your business will heavily impact the way the buyout takes place. A limited company, for example, has directors with a certain amount of shares - usually 100% for a sole director or 50/50% for a partnership. 

Buying out a director in a limited company is, in an ideal world, a fairly straightforward concept: you value the shares as above, and that forms the basis of the asking price. There may be additional elements the exiting director feels they should be compensated for, such as intellectual property (IP), but that will be part of the negotiations. 

However, there are multiple routes to purchase that make this more complex. They are mainly:

• Company buyback: this is when the departing shareholder sells their shares to the business itself. These shares are then cancelled to leave other shareholders in control. Alternatively, they can be redistributed only as bonuses under the Companies Act. 
• Share sale: the most common and effective route is for a shareholder to buy out the other shareholder through a lump sum or a structured payment agreement. This must be done in agreement with any other shareholders and the purchase must be made by the buyer themselves and not the business. 
• Holding company purchase: a third option is to set up a holding company that buys the trading company’s shares. The director who is leaving then takes the cash value for their shares, with the remaining shareholders exchanging their shares from the trading company with the holding company to acquire the departing director’s shares. 

Other business structures, such as limited liability partnerships (LLP), community interest companies (CIC) or partnerships will have different considerations that impact how you submit your offer and how you pursue the purchase. Contact Rangewell for advice if you’d like to know more. 

Have a solicitor take care of the legal aspects

UK law is complicated and often frustrating. While some matters are easy to negotiate internally, an acquisition is a complex and sometimes contentious process that is better managed by a solicitor. 

As a general guide, company buybacks and personal buyouts both require rigid contracts which outline the conditions of the sale, the payment structure and in many conditions the approval of a board or owner group. 

Because every business is different, we won’t try and guide you through the legalities of the buyout and will instead default to the professionals. Before you buy or sell shares, we’d suggest hiring an experienced legal professional on your side to help guide you through the whole thing. Rangewell can help you find the right support if you contact us ahead of the buyout. 

Tax implications of buying out a business partner

While tax issues vary business-to-business, the process for buying out a partner/director is fairly established. You should expect to pay stamp duty at 0.5% on the purchase of the shares themselves, whilst the seller’s tax liability varies depending on the structure of the sale. 

If the departing shareholder sells shares to the company, they may be charged income tax, which can be far most costly than tax levied on capital gains. To be treated as capital gains, the shareholder sale must meet capital criteria:

1. Shares sold to the business must have been held for over 5 years
2. Shares must be sold entirely or substantially reducing shareholding by over 25%
3. Post-sale, the departing shareholder cannot hold more than 30% share capital. 
4. The company buy-back must be to the benefit of the company’s trade, or to pay inheritance tax from a death. 

Contacting HMRC before a sale is therefore a good idea, as establishing whether the sale will be viewed as personal income or capital gains is important. The seller, provided they meet capital criteria, can use annual exemptions and Entrepreneur’s relief to reduce their tax liability. 

What if your business partner wants to buy you out? 

If you’re approached by a partner who wants to buy out your shares, this guide is still valuable as it will help you both understand the process. Unlike the situation we’ve covered in the guide, however, your goal as the seller is to try to maximise the value of your shares and to plan your financial withdrawal in the best way. 

Typically you’ll find that if you actively work with your partner to help them secure the finance they need to buy your shares, the whole process will be made simpler. As you negotiate the deal, you may also add certain conditions so that you can secure the best cash payout possible whilst also ensuring the business continues to flourish following your departure. As noted in our tax section, you need to decide how you’ll sell your shares and what structure best supports your tax situation.  

How to raise money to buy out a director

Businesses are a valuable asset and share valuations can be high – which might dissuade some directors or partners from ever considering a buyout. However, finance can help you bridge the gap between available funds and the capital required to buy your director’s shares. 

The type of finance you secure will depend on the circumstances behind the purchase and the process you choose. Company buyback and personal share purchases require unique approaches. To help you understand which route is best for you and to build the best case for finance ahead of time, you should get in touch with our team as soon as you consider a buyout. 

If you do, we’ll be able to guide you through the process, identify lenders who will support your purchase and arrange finance at the best terms we can find, all without cost. Considering the complexities of the lender’s market and business sales, having our team on your side is invaluable. 

If you’re a director who wants to be bought out, we can also help. We’ll not only arrange an independent valuation, but we’ll help direct your partners/directors to the right finance provider and secure a loan that enables them to buy from you. Without our help, they may struggle to raise the finance required to buy you out, or you may have to compromise on the price of your shares or your lump sum. 

Maximise the value of your arrangement whichever side of the director buyout you’re on. Contact our team to see how we can help.