Private Equity

The British Chancellor, George Osborne’s, pre-election Budget abolished the ability for managers of private equity-backed companies to benefit from U.K. entrepreneurs’ tax relief (ER) by pooling their investments in a portfolio company through a single vehicle (Manco). Does this mean we have seen the end of Mancos, or other pooling vehicles in the U.K.? We think not.

ER reduces the rate of capital gains tax payable by U.K.-based managers on sales of their interests in portfolio companies from 28% to 10%. Although this is less attractive than the U.K.’s employee shareholders’ scheme (ESS) (which provides for completely tax-free gains), the tests for qualifying for ESS and ER are different. As a result, management teams remain keen to exploit ER where possible, either instead of, or alongside, ESS.

The two key requirements for ER are that a manager must hold 5% of the company’s share capital, by nominal value, carrying 5% of the votes. Where multiple managers are seeking to benefit from ER, these requirements quickly lead to an unacceptable dilution of sponsors’ voting rights, as well as possible difficulties in the share capital structure caused by management needing to hold a disproportionate share of the company’s nominal share capital. Consequently, management would pool their interest in a Manco. Provided that Manco owned 10% of the portfolio company’s nominal share capital and each Manager owned 5% of the voting rights in Manco, each manager could benefit from ER on a sale of his shares in Manco. Manco did not need to have any voting rights in the portfolio company.

One significant drawback of using a Manco was that ER would only apply on a disposal of shares in Manco. As a result, on a sale it would be necessary to convince a purchaser to buy Manco, rather than Manco’s shares in the portfolio company, and ER would not be available at all on an IPO.

Notwithstanding the limitations of using a Manco for ER planning, it has always been preferable for sponsors if management’s interests in the portfolio company are pooled in one place. Employee benefit trusts (EBTs) have remained de rigueur because they enable the portfolio company to deal with a single legal owner of management’s shares and they make “warehousing” and transferring of shares sold by departing managers much simpler from a tax and logistical perspective. EBTs continued to be used alongside Mancos and we do not foresee any change in this. Where there is no EBT, we still recommend that some form of pooling vehicle (which can be a company or a limited partnership) is used as the practical benefits to a portfolio company of dealing with a single shareholder, rather than several individuals, are substantial.

As a result, while this change in U.K. law may have removed one reason for keeping all of management’s eggs in one basket, there remain compelling reasons for pooling management’s interests in one place, wherever management are based. We have not seen the last of Mancos.