31 December 2010

Discretionary dividends

Allocating dividends unequally across shares in a company

Gerry Jackson of Critchleys made an interesting blog post yesterday reminding us that paying dividends is almost always more tax-efficient for owner-managers than paying bonuses.
I commented about giving the directors a discretion to pay different dividends on separate classes of shares. We corporate lawyers often get asked by tax advisers to change the articles to do that. It allows the company to pay dividends otherwise than in proportion to shareholdings, either to maximise tax-efficiency or to reward contribution to the business – close to being disguised remuneration. But it has legal implications:
  • Directors have duties to act in the interests of the company and to treat shareholders fairly, which usually means equally, and the exercise of discretion in any other way could be criticised later or challenged in court.
  • It becomes difficult to value any particular block of shares, as the dividends attached to them vary depending on the exercise of the discretion. That difficulty could be exploited by HMRC in some circumstances: see (for instance) example 3 in the HMRC manual on "Securities with Artificially Enhanced Value". The value of the shares may go up and down depending on the history of dividend declarations, and there is no guarantee that the holder will get the same price per share as other shareholders when the company is sold.
  • HMRC may attempt to characterise dividends as disguised remuneration, depending on how the discretion is exercised.
  • HMRC may seek to attack discretionary dividends under the settlements legislation, especially when the beneficiary is the spouse, civil partner or minor child of the person not receiving the dividend: see the HMRC manual on this. 
  • The power to allocate dividends could be abused by directors. Even if the shareholders are directors, decisions could be made by a majority or if a director were absent. Except possibly in husband and wife companies, some protection is usually advisable, and I have some strategies to achieving that protection.
Two further points to add about taking remuneration as dividend. First, it may reduce the amount you can claim on dismissal, including following insolvency, or affect the amount of the pension contributions you can make. Second, remember that dividends have to be covered by distributable profits. My insolvency practitioner friends all have stories of unfortunates who continued to pay themselves by dividend as the company started to make losses, only to have the dividends reclaimed after the company went down.

30 December 2010

How can I sell my business?

The state of the mergers and acquisitions market
for private companies in the UK

As we enter 2011, is there hope on the horizon for entrepreneurs looking for an exit?
Not much, it seems. The national statistics and the mood amongst corporate finance professionals show the same gloomy picture for M&A activity. Q2 2010 saw only 47 UK acquisitions of independent UK companies over £1m  – perhaps one for every four law firms specialising in this work!
There is little doubt that the UK corporate sector is recovering from recession. In many sectors, notably those manufacturing for export, modest profitability and stability has returned . But that is not fuelling acquisition activity, and it remains very hard to sell your business.
The key to the problem is bank lending. UK banks continue to be extremely cautious, and are generally not willing to support expansion through acquisition, nor to provide leverage for private equity investment. That destroys the investment model for private equity – without a high level of debt, the investor cannot make the equity returns needed. Although the banks say their approval levels are at record highs, bank lending is focused on supporting existing customers and avoiding driving businesses under. The UK clearers have also had to take up lot of capacity from foreign banks withdrawing from the market, notably the Irish banks.
Almost all buyers need funding, and there are still no obvious alternatives to the banks. As most of the world has the same problems, there has been no influx of foreign lenders. In the old days the fall of sterling might have attracted them, but not now. Nor are foreign buyers flocking to the UK. Cash buyers should be able to pick up bargains, but those with cash are hoarding it, perhaps concerned about whether they will be able to raise finance for their own businesses over the next few years.
In the past, rising stock markets have led to booms in acquisitions by listed companies, but that isn’t happening either. The record sums being raised are going to bolster corporate balance sheets and reduce dependence on bank funding. There are some signs of personal or corporate cash balances being used to provide debt funding to corporates, cutting out the banks as middlemen, but not on the scale needed to make a difference.
Uncertainty and lack of business confidence make potential buyers or private lenders just as wary as the banks’ credit committees, so prices are driven down and even good businesses struggle to convince investors of their prospects. The uncertainty flowing from the public spending cuts is particularly destabilising.
In the SME market there is now a backlog of entrepreneurs looking to exit or retire, and few prospects for realising value. Most deals we are seeing are self-funded partial exits, with vendors handing over to a new generation of management for a deferred price paid out of the company’s cashflow. Inevitably that limits the price the seller can expect for his lifetime’s work, and leaves him with much of the risk while sacrificing the upside. The beneficiaries should be the next generation of management, who can gain ownership with little personal risk and good long-term prospects. We keep hoping for an improvement, driven by competition from outside the UK banks, but it isn’t here yet.
So for the time being there are bargains to be had, but few buyers with the resources to pick them up.

[1] Office for National Statistics Statistical Bulletin: Mergers and acquisitions involving UK companies 2nd Quarter 2010
[2] Eg CBI press release 18 November 2010 Demand improves for UK-made goods