Banking Entrepreneurs’ Relief on a dilution

The issue

In Spring 2018, the Government published a consultation setting out its proposal for allowing shareholders to retain the benefit of Entrepreneurs’ Relief (ER) when certain dilution events occur. Historically there have been many cases where shareholders lose future ER benefits as a result of their shareholdings dropping below the critical 5% mark as a result of inward investment. The policy decision is that the Government do not want shareholders to lose ER entitlement (a bad thing) as a result of receiving inward investment (a good thing).

Draft legislation has now been published to be included in the Finance Bill 2018-2019, potentially applying from 6 April 2019.

 

The new rules

Shareholders will be able to benefit from the new rules where their shares are reduced below 5% as the result of the company raising funds for commercial purposes by means of issuing new shares. In these circumstances the legislation will provide for that individual to be able to elect to be treated as having disposed of and reacquired their shares immediately prior to the dilution event, triggering a gain on any increase in value up to that point, on which ER would be available. There is also a second election which allows the individual to defer this gain until a time when the shares are sold.

Importantly, individuals will be allowed to value their shares on the assumption of a whole company sale, as opposed to applying a minority discount. This is clearly an important point in making the legislation attractive because otherwise any ‘elected gain’ would (by definition) be very small and therefore of limited value.

 

Final comment

Although these rules are positive, they may not be as attractive as they sound. It may in practice be difficult to justify a significant value on a company at the time when reinvestment occurs. For example many technology companies require the additional investment to truly realise their value and therefore the entrepreneurial founders may still effectively be ‘crowded out’ of their ER ‘entitlement’. There is still no protection for any increase in value which takes place after the dilution event.

The above comments notwithstanding it is worth considering deferring new investment runs until after 6 April 2019 in a bid to avoid various diluted shareholders feeling robbed of their ER entitlement.

 

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