There are many factors that impact on people’s willingness and enthusiasm to undertake transactions, and there is little doubt that the long drawn-out process of Brexit is having an impact as well. In general terms high transaction volumes tend to require four key elements:
- A degree of certainty regarding the future;
- Adequate funding available to undertake the transaction;
- The cost of funding to be serviceable; and
- A favourable tax regime.
We all know that there will be change as a result of Brexit – we just don’t know the extent of it. As there is no certainty of what Brexit will actually entail, it is currently down to each individual’s view as to the degree of uncertainty over the future that it will cause. Consequently, even for people in similar businesses, their view of the future may be different.
From a UK-wide perspective, deal volumes have remained quite resilient since the Referendum, as shown by the graph below:
Immediately after the vote there was a decline in Real Estate related transactions – especially in London as people felt that the Financial Services sector would be badly hit. However, even this bounced back as the risk was reassessed and deals that had stalled were revived and completed later in the year.
The position in the SW has been somewhat different:
Deal volumes immediately prior to the Referendum were at their highest quarterly level ever. Following the vote there has been an ongoing decline which appears to have accelerated in 2018 such that quarterly volumes are now 40% below the peak. At PKF-Francis Clark we find this somewhat surprising as in the first six months of this fiscal year we have seen a 25% increase in the number of clients that we have advised regarding funding and transactions.
Turning to some of the other factors that influence deal volumes, the current funding climate is such that there is more funding available than there has probably ever been before. Not only is the quantum greater, but also the range and type of funding has exploded over the last decade with the development of ‘Alternative Finance’ (AltFi) and a myriad of new funding structures which have come with it that are now available to SME’s.
Whilst certain debt funders are being a little more cautious, this is mainly with regard to certain sectors, with there being no wholesale reduction in appetite – as there was during the financial crisis. In addition, AltFi has not experienced any form of downturn, and increased competition in the sector is driving down margins, rather than increasing them to reflect any perceived increase in risk.
The quantum of funding available has partly been driven by low global interest rates – money left in a bank account currently earns little and so individuals have been hunting for a higher yield – whether or not they fully recognise the extent of the additional risk that they are taking to obtain it.
Finally, the current rate of Entrepreneur’s Relief (if the conditions are met) is such that the capital gains tax (CGT) cost may only be 10% on the first £10m of gain (more than enough for many people), when they are selling shares. When compared to the tax on bonuses (up to 45% for a high earner, plus EE’s NI and ER’s NI), and 38.1% for dividends, the difference is so significant that many clients want to make the most of it.
I can’t see that capital gains tax on significant disposals is going to get lower anytime soon, and there is a risk that people look back in years to come and wish that they only had to pay 10%! The latest Budget has indicated that even the Conservatives see that ER was too generous and restrictions on it are increasing.
With all other main parties having previously said that they are looking to align CGT rates to be more in line with income tax (and with an expectation that income tax rates would increase as well), the effective rate under that scenario could move from 10% to nearer 50%.
For many entrepreneurs, their basic retirement plan is to continue to grow their business so that it is worth more and they have higher post-tax proceeds to retire on than if they sell ‘now’. However, we now have a situation where they could work hard for several more years and the post-tax proceeds could be substantially lower than they would be today – not exactly an incentive to work hard and drive the value upwards!
To assist clients with these concerns we can often use the low cost of today’s funding to enable them to realise some of the capital value and take this out at a 10% tax rate – a significant saving to the 38.1% dividend rate if nothing else! For those that still see the potential for future growth and think that the chances of increased CGT (under any Government) is lower, we can often structure a transaction so that they can still benefit from some of the upside should this occur in the years to come.
In today’s uncertain world – influenced further by Brexit and the potential for tax changes, the current funding climate enables us to structure transactions so that many entrepreneurs don’t have to decide whether to sell all of their shares or retain them all – they really can take cash out and retain upside potential – yes you can have your cake and eat it! – but for how long?
For those that are happy to retain 100% ownership and the risk and rewards that go with it, in view of the additional uncertainty created by the drawn-out Brexit process, they may well want to consider the following operational/day to day matters:
- Reviewing the working capital cycle to see whether it can be improved in quantum, or shortened in timescale. If this hasn’t been done for a while it can release cash with no borrowing cost!
- Ensuring that there are suitable funding facilities in place – not just the quantum but also the type and FX (where appropriate) to allow adequate headroom in case there are delays in your supply chain or you wish to do some stockpiling;
- Considering Government schemes such as Export Finance support to see if they can ease the pressure on your Bank and increase your borrowing capacity;
- Reviewing covenants (especially if they were set several years ago) to ensure that they also allow adequate headroom to minimise the chance of tripping up on them unexpectedly; and
- Considering the use of AltFi if the perceived risk for your traditional funder is getting too high for them.
Finally, re-evaluate the risks that face your business and ensure that you have at least considered what you can do if some of them start having more of an impact. Quality thinking can take time and so it’s better to start sooner than leave it because you are too busy with the (current) day job!