Proceeds from the sale of a start-up can take many different forms, each carrying with it an array of benefits and limitations depending on what the selling entrepreneur wishes to do next, both with the funds and with their subsequent endeavours. 

In this article we outline some of the most common types of consideration an entrepreneur might receive and the implications.

This article forms part of our 'Business assets and liquidity events' series on the issues and opportunities for founders, or early individual investors, upon a liquidity event. Further issues in this series can be found at the bottom of this article.

Cash

Cash is the most straightforward form of consideration on a sale of a business. It provides the selling entrepreneur with immediate liquidity, which could be welcome if the entrepreneur is seeking access to funds for other purposes, such as passing wealth down to the next generation or new business ventures. A cash sale could also offer the entrepreneur a clean break from the business.

Cash receipts for the disposal of a business will, generally, be subject to capital gains tax, although certain reliefs may be available. In particular, if certain conditions are met, business asset disposal relief (BADR) may apply such that the first £1 million of any gain is taxed at a rate of 10% (please note that this rate is expected to increase to 14% from 6 April 2025, and again to 18% from 6 April 2026, following the Autumn Budget).

If the shares being sold are held personally the cash proceeds will be in the entrepreneur's estate, which could create additional exposure to inheritance tax. If appropriate, it may be possible to take steps pre-sale so that all, or part, of the cash sale proceeds pass to a family trust or to other family members as part of succession planning to mitigate inheritance tax, although care will be needed to ensure that advantageous reliefs are not jeopardised in the process. Our earlier article considers planning for business assets using trusts.

Shares

If the business is being merged with, or is being acquired by, another company, the consideration may take the form of shares in the acquiring entity, or loan notes. This form of consideration may provide opportunities for the deferral of tax liabilities, as well as for future tax planning. In particular, it may be possible to rollover any gain in the value of the shares in the target business and defer the payment of tax on that gain until the ‘new’ shares, or loan notes are disposed of. However, if the entrepreneur would be eligible for BADR on the disposal of their shares in the target, it will be important to consider whether it is more advantageous from a tax perspective to crystallise the gain on the disposal of the shares in the target (taxed at 10% on completion to the extent BADR applies, although please note comments made above in relation to rate increases following the Autumn Budget) rather than to claim rollover relief. This is because the entrepreneur may not qualify for BADR on a future disposal of the ‘new’ shares.

If the entrepreneur intends to continue being involved with the merged business, taking part of the consideration in shares, or loan notes, could provide an excellent opportunity to align the interests of all parties. In the long-term, this could prove beneficial to the entrepreneur if the performance of the new business is strong, yielding significant returns.

However, the reinvestment (in practical terms) in a new business will carry with it investment risks and could also represent a lost opportunity to capitalise on the sale and create liquidity out of the event, noting that the next such opportunity might not be until the sale of shares in the new business. Moreover, when accepting shares as consideration, it is prudent to closely analyse the share terms to ensure a future exit could be made as and when desired.

Deferred and contingent consideration

Sometimes, part of the purchase price is deferred to a future date post-completion, or is contingent on future events or performance. This would include earn-out arrangements, which allow the selling entrepreneur to receive additional compensation based on the future performance of the business.

Whilst this could create an overall increased return for the entrepreneur, the additional consideration may not be guaranteed and the provisions relating to it are often heavily negotiated as part of the sale. 

In addition, deferred and/or contingent consideration could create additional tax complications, which should be reviewed as part of the pre-sale tax planning. Where a sale includes substantial deferred or contingent consideration this can trigger significant tax charges for the tax year on completion of the sale, regardless of when or if such amounts are eventually paid. However, where the amount of the deferred and/or contingent consideration is unascertainable at the time of the sale, further tax liabilities can arise in the future. A seller’s entitlement to earn-out consideration should ideally be linked only to the performance of the company (and not any individual) and should not be conditional on any individual’s ongoing employment (among other things) to maximise the likelihood that it is taxed as a capital receipt. The potential for further tax exposure in the future could also impact on wealth structuring and succession planning. 

Although the type of sale proceeds will often be dictated by the sale negotiations, entrepreneurs should consider both immediate financial returns and long-term benefits when evaluating the proposed consideration in light of their personal goals and circumstances surrounding their exit.

Whilst the types of consideration discussed above are most common, certain sale structures may result in alternative arrangements being put in place, or indeed a selection of different types of consideration may be used as part of one sale to achieve the objectives of the varying parties. It is important to remember that each form of consideration has specific legal nuances and will be taxed in a different way, and so tailored advice should be sought to ensure the agreed type will not hinder post-sale plans.

If you have questions or concerns about key considerations ahead of the sale of a business, please do not hesitate to get in touch with a member of our Private Client team.

This article is not intended to constitute legal advice but should serve as general guidance on this topic for business owners upon a liquidity event.