How to avoid cashflow pitfalls when selling your business

If you’re planning to sell your business, you’re probably already thinking about what to do with the proceeds once you’ve closed the deal.

Ideally, you’ll want to have laid the groundwork before you sell, so you can get the proceeds working for you right away. The best way to do this is by creating a wealth plan that details your and your family’s medium-term financial needs and aspirations, along with an investment strategy designed to support these goals. It sounds simple, but many entrepreneurs fail to account for the implications of their sale agreement on their cashflow, which could undermine the viability of their chosen investment strategy.

So, identifying the cashflow pitfalls that lie beyond the sale of your business and designing your investment strategy to avoid them is vital if your wealth plan is to succeed. However, the nature of these pitfalls is heavily dependent on the structure of your deal – and no two sale agreements are the same.

Many entrepreneurs fail to account for the implications of their sale agreement on their cashflow, which could undermine the viability of their chosen investment strategy

How your sale agreement can affect your future cashflow

Anticipating your post-sale cashflow can be tricky even with relatively straightforward, cash-only deals, which are few and far between. With more complicated deals, cashflow forecasts become even more difficult, and even more important.

This is because the most significant influence on your post-sale cashflow is when and to what extent the proceeds will be taxed – which, in turn, depends on how and when the proceeds are disposed. If your wealth plan is to succeed, it must account for all the taxes that will be levied on each component of your sale proceeds.

Cash

Even with cash-only deals, the final post-sale balance sheet could trigger clawbacks or adjustments to the amount you received. Sometimes, the deal includes certain conditions that could change the amount you receive later. If you’re selling shares, employment rules can sometimes carry tax implications. However, in most cases, the most important consideration is Capital Gains Tax (CGT). Any CGT owed on the cash you receive from the sale will be due by 31 January after the tax year in which the sale happened.

Paper

Some deals include a paper component, in which some of the proceeds are paid in the form of shares or loan notes in the post-sale company. In some cases, you can defer paying CGT on the paper component of your proceeds until you sell the shares or redeem the loan notes. You don’t need clearance for this if the relevant conditions have been met; but if you’re unsure, check with HMRC before the sale takes place. Many business sale agreements include a phased schedule for redeeming loan notes, which can help optimise your post-sale cashflow.

Earn-outs

In an earn-out arrangement, payment of some of the sale proceeds is deferred to a later date and made in one or more stages. The amount you receive depends on how well the business performs (in terms of factors like turnover and profit) over a set period after the sale, often two to three years or more. Earn-outs ensure that the former owner and their pre-sale management team maintain a vested interest in the business’s performance, and they often remain actively involved in managing the post-sale business.

If your wealth plan is to succeed, it must account for all the taxes that will be levied on each component of your sale proceeds

The taxation of earn-outs is particularly complicated. Tax law treats the value of earn-out rights as part of the initial sale price, and they’re considered as distinct assets for CGT purposes. So, using data from business plans and projections, you’ll need to estimate and agree on the value of your earn-outs with HMRC at the time of the sale and pay CGT on that agreed valuation along with the cash you receive.

However, tax law also treats the actual earn-out payments as separate transactions in the year they’re received. If you receive an earn-out payment in a subsequent tax year that’s higher than the value you agreed with HMRC at the time of the sale, you’ll simply need to pay CGT on the excess. But if an earn-out payment is lower than the value you agreed with HMRC, a capital loss will arise in the tax year of the payment. This loss can’t be offset against the higher value of the earn-out rights you received and paid CGT on in the year of the sale, leading to a potential tax mismatch. You can avoid this pitfall by ensuring your sale agreement states that your earn-outs will be paid in buyer-issued loan notes, though certain conditions will need to be met for this to work.

Read also: Should I stay or should I go? A practical guide to the UK’s non-dom tax changes

What all this means for your post-sale cashflow and investments

Normally, investment strategies are designed around the client’s time horizon and risk appetite. This works well for straightforward mandates where there’s no foreseeable need to withdraw funds from the account, but some clients need more complex mandates that offer more flexibility.

This is often true of clients who have sold their business and want to invest the proceeds, which seldom arrive as a single, clean cash disposal with an easy-to-calculate, one-time CGT payment. Such rarities aside, the client will probably expect to receive multiple disposals over several years as staged loan-note redemptions occur and earn-out payments are triggered – each of which will come with a tax bill attached. These clients need investment strategies that balance returns with liquidity to ensure they have the means to pay these taxes when they’re levied.

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So, if you’re planning to sell your business and invest the proceeds, it is essential that your investment manager and wealth planner understand the structure of your deal. This will enable them to design a coherent approach that accounts for the timing and form of each disposal and its expected tax bill, baking short-term liquidity provisions into your strategy to ensure the funds you need will be available when you need them instead of tying them up in medium-term investments.

If you’re planning to sell your business and invest the proceeds, it is essential that your investment manager and wealth planner understand the structure of your deal

It’s also worth discussing any further significant financial or lifestyle needs and aspirations you and your family may have – such as buying real estate or meeting capital calls – with your investment manager and wealth planner. This will enable them to design your investment strategy to provide for your liquidity needs beyond paying taxes on the sale of your business.

The expertise and technology you need

With a Fitch rating of AA- – the maximum for a bank in its category – and a Tier 1 Capital Ratio of 32%, Lombard Odier is often the bank of choice for clients who want to invest the proceeds from selling their business. Our extensive experience in this area has enabled us to develop not just our expertise, but also an in-house technology platform to support it.

Instead of starting with the client’s time horizon and risk appetite – which, as we’ve seen, isn’t appropriate for those with more complex liquidity needs – we designed the Your Wealth Outlook (YWO) platform to reverse-engineer the portfolio construction process. First, YWO analyses the client’s financial and lifestyle needs and aspirations, including any anticipated taxes, to understand their liquidity requirements over time. Next, YWO models a portfolio that balances optimal returns with the client’s future liquidity needs. Only then is the model portfolio tested against the client’s risk appetite and adjusted if necessary.

Our extensive experience in this area has enabled us to develop not just our expertise, but also an in-house technology platform to support it

Selling your business is a significant milestone, and it’s crucial to manage the proceeds in a way that comprehensively accounts for any taxes that could impact your cashflow and, in turn, your financial future. Working with a knowledgeable wealth planner and leveraging forward-looking investment planning technologies like our YWO platform will enable you to avoid these cashflow pitfalls. With a tailored strategy that meets your investment goals and your liquidity needs in hand, you can sell your business with the peace of mind that comes with knowing the proceeds will enable you to live the life you want, whatever you plan to do next.