Once the purchase price for a business has been ascertained the purchasers need to consider how to fund the purchase. Usually it will be through a combination of money put in by the employees themselves, which they have as savings or which they borrow, or by way of a loan to Newco from a bank or other lender. Occasionally it will be through an outside investor investing in shares alongside the employees.
If the target company has been trading profitably for some years an alternative way to reduce the purchase price is for the existing shareholders to make a pre-sale dividend or re-purchase of shares. This results in a pound for pound reduction in the purchase price.
Pre-sale dividends used to be quite tax effective, but the abolition of Advance Corporation Tax removes much of this advantage in 1999.
Under a re-purchase of shares a company purchases its own shares out of distributable profits. Not all the shares are re-purchased in this way, but simply an amount which uses up some of the distributable profits. The value attributed to the shares will relate to the purchase price which has been agreed. It then becomes a question of cash flow for the target company as to whether it has the cash to make the payment.
A purchaser who agrees to the cash balances of the target company being used in this way may require a working capital facility as a consequence. Alternatively, the company may need to borrow money to fund the purchase.
The owner who sells the shares of the company in this way will usually be subject to capital gains tax on the disposal of the shares. However, the difference between the original subscription price and the purchase price will be treated as a distribution of income, and only the balance will be subject to capital gains tax. Because of the indexation rules there is likely to be a capital gains loss.