Buying out a director: how it works and how to fund it

Buying out a director means purchasing the shares a director holds so they leave the company as an owner. The shares can be bought by the remaining shareholders, by an incoming investor, or by the company itself through a purchase of own shares. The price is normally based on an independent valuation, and the deal can be funded from company cash, a business loan or staged payments. Smart Funding Solutions, a commercial finance broker, arranges funding for director and shareholder buyouts.

Note that stepping down as a director and selling shares are two separate things. A director can resign or be removed without selling their shares, and a shareholder need not be a director. Most buyouts deal with both at the same time.

This guide is for the remaining owners of a limited company planning how to buy out a departing director, and how to pay for it. Smart Funding Solutions is a broker: where borrowing is needed, we approach lenders with an appetite for shareholder exits and manage the application. Our acquisition finance guide explains deal funding more generally.

01Common reasons for a director buyout

• Retirement: a founder or long-standing director wants to exit and realise the value of their shares.
• Disagreement: co-owners disagree about the direction of the business.
• Change of strategy: the remaining owners want to restructure leadership or bring in new investors.
• Personal circumstances: ill health, relocation or a change in priorities.

02How can a director buyout be structured?

• Share purchase by other shareholders: the remaining owners buy the shares personally, often funded by personal borrowing or a loan to a holding company.
• Company purchase of own shares: the company buys back and usually cancels the shares. This must follow Companies Act 2006 rules, including shareholder approval and, in most cases, payment from distributable profits.
• Phased or deferred buyout: shares are bought in stages, or the price is paid over time, to ease pressure on cash flow.
• Investor or management buy-in: an outside party takes the departing director's stake. See our guide to management buy-in finance.

Check your articles of association and any shareholders' agreement first. They often set out how shares must be offered, valued and transferred when an owner leaves.

03How are a departing director's shares valued?

A fair price reduces the risk of disputes. The value depends on the company's profitability, cash flow, assets, growth prospects and the terms of any shareholders' agreement. Common methods include:

• Earnings multiple: applying a multiple to sustainable profits, a common approach for trading SMEs.
• Discounted cash flow: projecting future cash flows and discounting them to today's value.
• Net asset value: assets minus liabilities, often used for asset-heavy or property-holding companies.
• Comparable businesses: benchmarking against similar companies in the same sector.

Minority stakes are sometimes valued at a discount because they carry less control. An independent valuation from an accountant or corporate finance adviser is strongly recommended.

Check your articles of association and any shareholders' agreement first.

04Key terms to agree

• Price and payment terms: lump sum, instalments or deferred consideration.
• Restrictive covenants: reasonable non-compete and non-solicitation clauses.
• Confidentiality: protecting company information after the director leaves.
• Release of claims: settling any outstanding loans, guarantees or employment claims.
• Personal guarantees: arranging for the departing director to be released from any guarantees on company borrowing, which lenders must agree to.

05Legal considerations

Directors must act in the best interests of the company under the Companies Act 2006, avoid conflicts of interest and make full disclosure. A company buyback needs the correct shareholder resolutions, must be paid for in line with the Act and has to be reported to Companies House. Take specialist legal advice before agreeing terms.

£137,500A transaction we arranged£137.5K to fund an accountancy practice acquisition.An established firm had an acquisition agreed. We structured the funding around the transaction and got it completed.

06How is a director buyout taxed?

How the buyout is taxed depends on its structure. A sale of shares to another person is usually subject to Capital Gains Tax for the seller, and reliefs may be available. When a company buys back its own shares, the payment may be taxed as income unless specific conditions for capital treatment are met. Stamp Duty may also apply to share transfers. Get professional tax advice early, as the structure can make a significant difference. HMRC publishes guidance on company purchase of own shares and Capital Gains Tax on GOV.UK.

07How can you fund a director buyout?

Company cash reserves

Using retained profits avoids new debt, but it reduces the cash available for day-to-day running and growth.

Business loans

A term loan to the company, or to a new holding company, can fund the purchase while keeping cash reserves intact. Lenders will look at profits, cash flow and whether the business can service the debt once the director has gone. Structured acquisition loans and secured business loans are both commonly used.

Releasing cash from assets

Asset refinancing or invoice finance can release money tied up in equipment or unpaid invoices to help fund the payment.

Deferred payments

Paying the departing director in instalments can reduce the amount you need to borrow up front. Lenders will usually want any deferred payments to rank behind their loan, so agree the order of payment before approaching them.

What lenders ask about a director buyout

• Will profits and cash flow cover the new repayments once the director's salary or dividends stop?
• Did the departing director bring in key customers, contracts or skills, and how will those be kept?
• Is the agreed price supported by an independent valuation?
• What security is available, and will the remaining owners give personal guarantees?
• Are the company's accounts, management figures and tax affairs up to date?

08Communicating the change

Tell employees, key customers, suppliers and lenders what is happening and why. Clear messages about continuity help protect relationships during the transition.

09Steps in a typical director buyout

1. Check the articles of association and any shareholders' agreement.
2. Obtain an independent valuation of the departing director's shares.
3. Take legal and tax advice on the structure before agreeing heads of terms.
4. Arrange funding, if needed, and agree how any deferred payments rank against lender debt.
5. Pass the shareholder resolutions, complete the transfer or buyback and file with Companies House.
6. Release the departing director from personal guarantees and update bank mandates.

10Common mistakes to avoid

• agreeing a price without an independent valuation
• overlooking the shareholders' agreement or articles of association
• leaving tax planning until after terms are agreed
• missing shareholder approvals or Companies House filings
• forgetting to release the departing director from personal guarantees

If you need to fund a buyout, we can review the proposed price and structure, approach suitable lenders and go through the offers with you. Lenders make the final decision. It is free to enquire; any broker fee is disclosed separately before you proceed. Discuss your buyout funding in confidence.