- There are two important questions for buyers and sellers to consider with this type of deal. Can the business afford to provide the funding, and can the arrangement be structured in a way that meets both the necessary legal and tax requirements?
- There are different ways that an arrangement of this type could be approached and structured: seller finance, loan from the business being acquired and payment from future profits.
- Having poorly structured or documented loans can have major consequences beyond a future dispute over repayment.
Buying a business does not always mean having to find the full purchase price upfront. In some circumstances, the business being acquired can help to finance the deal, but there are a number of legal and tax considerations that both buyers and sellers need to understand.
There are two important questions for buyers and sellers to consider with this type of deal. Can the business afford to provide the funding, and can the arrangement be structured in a way that meets both the necessary legal and tax requirements?
Take for example a buyer who is acquiring a privately owned business for £1 million. They can secure funding for £700,000 but need another £300,000 to enable them to complete the deal. The business being acquired has £300,000 in cash in the bank.
How that £300,000 can be used to support the acquisition will depend on the structure of the transaction, including when the money is made available and to whom.
There are different ways that an arrangement of this type could be approached and structured.
Seller finance – The seller accepts part of the purchase price at a later date which extends credit to the buyer. Important legal considerations include repayment terms, any security provided and the seller’s exposure if the buyer cannot pay the remaining amount.
Loan from the business being acquired – The business lends the money to the entity or individual buying the business. Legal issues here will focus around meeting director’s duties, having the necessary corporate approvals and considering the potential tax liabilities.
Payment from future profits – The buyer will use future dividends or other lawful payments from the acquired business to service the debt. Key legal considerations here are around the availability of future profits, the effect on cashflow, the tax liabilities this will incur and the effect on the businesses overall financial position.
Whichever approach is taken, the arrangement needs to be properly documented and agreed before the acquisition completes. Where a loan is being made, the agreement should clearly identify key information including the lender and borrower, the amount being advanced, the interest payable, the repayment schedule and what happens if the borrower defaults.
It is also important to establish whether the loan is in the interests of the company providing the money. All directors have legal duties to the company, and these do not disappear simply because all of the shareholders support the transaction. A loan that leaves the acquired business short of working capital, or which has little prospect of being repaid, could create significant problems.
Where things go wrong
Having poorly structured or documented loans can have major consequences beyond a future dispute over repayment. Depending on who receives the money and how the transaction is arranged, there may be unexpected and significant tax liabilities, questions raised over whether the directors have fulfilled all their legal duties and difficulties and the cost of recovering the money if the business subsequently fails.
For example, certain loans made by closely held companies to shareholders can trigger a Corporation Tax charge if they remain outstanding beyond the relevant deadline. This can create a significant cashflow liability for a business, even where the loan is ultimately repaid.
The important point for buyers is that these arrangements need to be considered at the outset of negotiations. Legal and accounting advisers should work together closely to establish the most appropriate structure, understand the tax consequences and ensure that the necessary agreements and approvals are all in place before completion.
Ultimately, using the financial resources of a business to help fund its acquisition can make an otherwise unaffordable deal possible which can be an attractive option for both parties. However, getting the deal over the line should never come at the expense of the future financial health of the business being acquired.
Peter Kouwenberg is a partner at Taylor Walton Solicitors.
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