A Foredoomed Direction of Travel ?

Like many corporate finance advisory firms, the HMT team breathed a sigh of relief on 30^th October when capital gains tax on the sale of a business was raised much more modestly than had been feared. The higher rate increased from 20% to 24% rather than a rate of up to 45% which was threatened with the purpose of aligning capital gains rates with income tax rates.

In most cases, would be vendors and investors seem to have shrugged their shoulders at this increase and whether or not the Government’s PR strategy was intentional here, there is currently a positive sentiment of “Phew ! ….. it could have been much worse” However, there continues to be a risk that future budgets will incrementally move capital gains tax rates closer to income tax rates. The tax burden on the sale of a business will therefore gradually increase beyond the impact of the measures of scaling back the benefits of Entrepreneurs Relief from the recent budget.

Despite strong and growing negative public sentiment towards the recent budget, there is probably more to come in terms of tax increases and we now know that “working people” is a much narrower definition than we might have imagined pre-election. However, looking on the bright side, the Government has demonstrated some concern for the competitiveness of the UK in business tax terms and has, so far at least, ensured that comparatively the business tax burden in the UK remains in line with other G7 countries.

In addition to the risk of an increasing capital gains tax burden, there are other issues would-be vendors need to focus on to ensure that they understand and reflect changes in the budget as they contemplate an exit.

The changes to national minimum wage and the increase in the rate of Employers NI will have a direct impact on the forecast EBITDA for almost all businesses. Raising the salary level for the lowest paid members of staff will, typically, have a knock on effect on salary levels throughout an organisation and we have already started to see this as clients respond to the budget changes. The degree of profit impact this will have will obviously vary with the scale of payroll and perhaps will lead to different decisions around employment vs contracting and offshoring vs recruiting UK teams. The use of technology to drive efficiencies and reduce staffing costs is likely to accelerate, particularly as AI starts to yield genuine use cases.

As the Government strikes a more interventionist note than we have been used to over recent years, it will be interesting to see whether a focus on particular sectors of the economy will have a knock on effect on investor and acquirer appetite. The narrative and energy around the property and construction sector has already seen a discernible positive shift and with the Chancellor’s focus on specific aspects of financial services in this month’s Mansion House speech, we might also see increased interest in aspects of sustainable finance, insurance and fintech (already a “hot” sector).

In the longer term it will be interesting to see whether the Government’s enthusiasm for harnessing accumulated pension pots to support investment in infrastructure, but also in private equity funds, will yield any kind of multiplier effect for the mid-market entrepreneur. The plans so far feel more like sound-bites than strategies and the detail behind the combining of local government pension funds to create a national investment fund suggests that the plans may encounter challenges en route.

The anticipated attack on private equity carried interests has so far been modest, and while further efforts to ensure that income is not able to be taxed as capital are clearly on their way, it is also clear that this will be subject to consultation and there is a wish not to impact the overall appetite for private equity investment while addressing a potential unfairness in the current system. It does not seem likely that for mid market businesses seeking private equity investment in the medium term, this is likely to have any material effect.

Finally, it may be that we are about to see a new corporate finance opportunity in the capital markets arena. Over recent years investors and entrepreneurs have typically ceased to see UK capital markets as a feasible exit route and the path to an IPO has been fraught with uncertainty (and cost). It is to be hoped that the planned PISCES market and other reforms to capital markets which are, as yet, a gleam in the Chancellors eye, might increase the options for UK entrepreneurs as they think about an exit.

In the short term, whilst the direction of travel has been set it seems to be business as usual, albeit with some slightly depressed profits and continued concerns about the balance between the cost of employment and the cost of living. In the medium term there is much that could go wrong with the Government’s strategy, not least the impact of global geopolitics, but there will always be opportunities for the brave and clever and as corporate financiers we look forward to supporting those entrepreneurs to build and realise wealth whatever the backdrop.

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