Raising funds to buy out a friend

GD writes: Three years ago I started a business importing computer peripherals from the Far East. I did not have sufficient capital so I sold 20% of the business to a friend for £10,000. Business has gone well with current profits of £100,000 before tax. I would now like to get back the shares held by my friend. I was shocked when he told me he wanted much more than £10,000 as the company is now making profits. Is this right? If I have to pay him a much larger sum, how can I raise the money?

Answer

Your friend is correct. As your company has done well, it will have become more valuable and therefore your friend´s shares would have increased in value. The first thing you should do is look at the company´s memorandum and articles to see if there are regulations that would cover this situation. Sometimes the articles will contain a formula for valuing shares, or they may, if a valuation cannot be agreed, allow the auditors to provide a valuation. Similarly, the articles sometimes provide that no discounts need be taken into account for minority holdings. As for your second point, you should consider whether there is any scope for the company to buy back these shares. Providing the company has been making profits and has revenue reserves, it is a straightforward matter for a company to buy back its own shares. This means you can use the company´s money rather than your own, although the tax implications for the minority may need to be considered as the money may be treated as an income distribution rather than a capital payment. If the articles have the appropriate provisions then this route is possible for you, but you should consider the impact on the company´s balance sheet carefully before proceeding. As you have 80% of the shares it would be a straightforward exercise for you to change the articles. Alternatively, if you decided to buy back the shares using your own money and you took out a loan to purchase the shares, any interest charged on the loan would be allowable against your personal tax bill.