Tax Implications of Earnouts
When planning the sale of a business, the tax implications should never
be overlooked. With careful planning and advice, maximum value can be
extracted from the sale. Often, however, hard-earned gains unnecessarily
slip through the vendor's fingers into the coffers of the Inland Revenue.
For anyone not familiar with the term, an 'earnout' will often occur
when a business is sold and there is difficulty in agreeing a value
fair to both vendor and purchaser. In such circumstances, an earn-out
represents further consideration for the purchase of the business. Typically,
the vendor will receive a cash sum, or an initial issue of securities,
plus an earnout consisting of one of the following:
-
A right to receive loan notes (issued by the purchaser)
after a certain period has elapsed and dependent on the performance
of the newly taken-over business. The loan notes would be redeemable
after a certain period or periods.
-
A right to receive securities in the purchaser or
its parent company after a certain period has elapsed and dependent
on the performance of the newly taken-over business. These may or
may not have restrictions placed on them.
-
Restricted (forfeitable) securities (shares or loan
notes) issued by the purchaser and which vest after certain performance
targets have been reached.
-
Convertible securities, issued by the purchaser and
which convert into a more valuable security after certain performance
targets have been reached.
As well as representing "further consideration", an attraction of earnouts
is that they allow for...
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Other areas covered:
Inland Revenue guidance
How to structure and earnout to avoid tax
Share transactions
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