Shareholder buyout finance for a departing director or co-owner

A company purchase of its own shares is the simplest structure on paper, but two rules decide whether borrowing can make it work.

Reserves, not cash, set the ceiling. A private company generally has to fund a buyback out of distributable profits. A loan puts cash in the bank but does not create reserves, so a company with £150,000 of retained profits cannot use a £300,000 loan to buy back £300,000 of shares in one transaction, however strong its cash flow. Borrowing helps only up to the level of reserves, unless the company uses the separate capital procedures, which your solicitor will explain.

Payment is due on purchase. Shares bought back by the company have to be paid for when they are bought, so a single buyback cannot be settled in instalments. Where the leaver agrees to be paid over time, advisers usually use a series of separate buybacks over successive years, each funded from that year's profits, or move to the holding company route. A lender funding a buyback therefore needs to be comfortable lending the full price for that tranche at completion.

How the leaver is taxed on a buyback also depends on meeting specific conditions, and advisers often apply to HMRC for clearance on a company purchase of own shares before completion. Lenders will usually wait for that to be settled.

When the stake is large or reserves are thin, the remaining owners often form a new holding company, exchange their existing shares for shares in it, and have the holding company buy the leaver's shares with borrowed money. Because the holding company, not the trading company, is the buyer, the reserves test on a buyback does not apply to the purchase, and the leaver can be paid partly at completion and partly over time through deferred consideration or a loan note.

The lender lends to the holding company and takes security and a guarantee from the trading company underneath. The same structure is used for team buyouts, described on our MBO finance page. The share exchange needs its own tax advice, and the holding company normally pays stamp duty on the shares it buys; GOV.UK explains the rules on tax when you buy shares. Lenders will want any deferred payments to the leaver to rank behind their loan; our guide to vendor finance and deferred consideration covers how that is documented.

For a small stake, one or two remaining shareholders sometimes simply borrow in their own names and buy the shares directly. The company's balance sheet is untouched, but repayments come from the buyers' own income, usually extra salary or dividends drawn from the company and taxed on the way out. In some circumstances interest on a personal loan used to buy shares in a close trading company qualifies for income tax relief, subject to limits, which your accountant can confirm. Lending secured on a home you live in is outside what we arrange.

Illustration. Two directors each own half of a company. One is retiring, and the agreed price for their half is £400,000. The company has £150,000 of distributable reserves and needs to keep about £100,000 of cash for working capital. The figures are hypothetical and not a quote.

A single buyback is not possible: the company cannot pay £400,000 out of £150,000 of reserves. Instead the remaining director forms a holding company, which buys the shares for £250,000 at completion, funded by a secured term loan, with the remaining £150,000 paid to the retiring director over three years as deferred consideration ranking behind the lender. The trading company pays dividends to the holding company to cover both. The lender's test is whether the company's profit, after paying a manager to cover the retiring director's role, meets the loan repayments and the deferred instalments with room to spare.

Borrowing to buy out a co-owner concentrates both ownership and risk in fewer hands. The remaining owners carry the debt and usually the guarantees, and a company that has spent its reserves and borrowed to the limit has less room for a bad year. Paying a fair price matters as much as funding it: overpaying because the exit is emotional, or underpaying and inviting a dispute, both cause trouble later. Alternatives to borrowing include a phased buyout over several years funded from profit, bringing in a new shareholder to take the stake, or letting the leaver keep a minority holding. In partnerships and LLPs the process is different; see our pages on partner buy-in finance and funding a solicitor partner buyout. Borrowing of £25,000 or less by sole traders and small partnerships can be regulated consumer credit, which brings additional protections.