Overview

A 20-year-old established firm that is a specialist supplier to the construction industry. Despite its current £5m turnover, the business was a partnership five years ago. Mr A owns the business and has been driving it for the past 12 years, with a four-man senior team over much of that time. The owner’s daughter works in the business, but is not expected to be part of any succession team.

The business’ annual turnover is £10m with gross profit of £2.2m, overheads of £1m and post-tax profits of £1m. Many employees are longstanding, having worked in the company for an average of 15 years. The owner has been frequently approached by an international PLC supplier to the construction industry, but has not wanted to sell.

Challenge

All the wealth resides in the business. The owner has only previously had very modest drawings, creating a sizeable imbalance of wealth/cash on the balance sheet, with a personal mortgage and debts in his own name.

While the owner does not want to sell in the short-term, there are four concerns:

  • There are no plans in place for succession nor for the business being able to continue if something happens to the owner (especially regarding the ownership of shares and intentions of estate rather than the business operating on a daily basis)
  • The senior team has no share of equity with only an ad hoc incentive scheme in place
  • Now in their 40s and 50s, members of the senior team are increasingly nervous about their own long-term positions (included being headhunted by the PLC)
  • Increased risk associated with a lack of long-term direction by the owner for the business

Solution

The solution was to create a new company.

Firstly, approval was obtained from HMRC confirming that the restructure of the business was entirely appropriate for its long term commercial future. The consequence of this at the same time ratified the significant tax savings achieved.

The result was that the new business was structured in two ways:

  1. The owner swapped his original ABC shares for a combination of £2m in shares and £3m in loan notes. This allowed the new structure of shares to be divided as follows:
    • 40% for the owner
    • 15% for the senior management team
    • 45% for the company’s Employee Benefit Trust (EBT)
  2. The EBT was created to issue options to employees/ future management under an appropriate share scheme. Once the firm deems the employees are ready to take over, they would be able to exercise their options to become beneficial owners.

Results

The new structure produced eight benefits for the new company:

  • Saving £600k in tax on the loan note elements as captured within Entrepreneurs relief considerations (20% of £3m)
  • Increasing post-tax profits by £120k and a slightly higher price-earning value which led to stronger contract agreements with key suppliers
  • The senior team are incentivised to drive the business forward as owners. This created a succession plan to allow the owner gradual withdrawal from the firm at a suitable time
  • The owner can sell more shares and draw loan notes over a period of time as the business can afford
  • The EBT is now used as a mechanism to attract new key hires
  • The owner was able to receive £1m in cash from the balance sheet and through small elements of debt funding
  • The reviewed balance sheet resulted in a renegotiation of supply contracts, which were paid by return (not including 60 day contracts). This resulted in decreasing costs by 6% across the board
  • The bank was happy to increase its funding due to stronger cash generation capabilities