The co-founder buyout we funded out of the business

The conversation rarely starts with the word "buyout". It starts with someone saying they are not enjoying it any more, or that their circumstances have changed, and the two of you agreeing amicably that they should probably step back. Everyone is relieved. Then somebody asks what happens to the shares, and the amicable part gets tested.

Because a 50% shareholder who steps back still owns half the company. Half of every future dividend, half of any sale, and a set of statutory rights that do not diminish because they stopped turning up. Agreeing that in principle they should be bought out is easy. Working out who pays, with what money, and what tax lands on it is where months go.

The figures below are illustrative, but the structure is the one most small companies end up with.

Three ways it gets funded

**The remaining shareholder buys the shares personally.** Cleanest legally, hardest practically. You need the cash personally, and it is cash you have already paid tax on. To find £120,000 net as a higher-rate taxpayer drawing dividends, you are taking well over £180,000 out of the company first.

**A new investor buys them.** Solves the cash problem and creates a different one: you have swapped a disengaged co-founder for an engaged shareholder with their own expectations, and the price now has to satisfy an outsider's view of value.

**The company buys its own shares.** This is what most small companies do. The business pays, the departing shareholder's shares are cancelled, and the remaining shareholder ends up owning 100% without personally funding anything. It is also the route with the most rules attached.

What a buyback actually requires

A company purchasing its own shares is regulated by the Companies Act, and the requirements are not optional formalities. Get them wrong and the transaction can be void, with the directors personally exposed.

The shares must be fully paid, and they must be paid for in full, in cash, at completion. There is no statutory right to pay in instalments — which matters enormously, because instalments are exactly what a small company usually needs.

The money must ordinarily come out of distributable profits: accumulated realised profits, not this month's bank balance. A company with £300,000 in the bank because it collected a big receipt and has not yet paid the VAT does not have £300,000 of distributable reserves.

There is a small exemption. Where the articles permit it, a private company can buy back shares out of capital up to a de minimis limit of £15,000 or 5% of its share capital in a financial year, whichever is lower, without the full procedure. For most buyouts that barely touches the sides. Beyond it, purchasing out of capital means a directors' statement of solvency, an auditor's report, a special resolution and public notice to creditors — doable, but a real piece of work.

Then the administration: a written contract approved by the shareholders before completion, form SH03 filed with Companies House within 28 days, and stamp duty at 0.5% on the consideration where it exceeds £1,000, paid to HMRC before Companies House will accept the form.

The company can afford it and the company is allowed to pay it are two entirely separate questions, and they are answered by two different documents.

The tax fork that decides everything

Here is the part that changes the price. When a company buys back shares, the default tax treatment is that the payment is a distribution — taxed on the seller as a dividend. From April 2026 dividend rates are 10.75% at the basic rate and 35.75% at the higher rate, with the additional rate at 39.35%.

The alternative is capital treatment under section 1033 of the Corporation Tax Act 2010, where the payment is taxed as a capital gain instead. Capital gains tax is 18% at the basic rate and 24% at the higher rate, and where Business Asset Disposal Relief applies it is 18% from 6 April 2026 on qualifying gains up to the lifetime limit.

On £120,000 that difference is not a detail. It is the difference between a seller taking home roughly three-quarters of the money and something considerably closer to two-thirds, and it is usually the seller who asks for the price to be adjusted accordingly.

Capital treatment is not a choice. The conditions include that the buyback benefits the company's trade rather than serving a tax purpose, that the shares have been held for at least five years, and that the seller's holding is substantially reduced — a reduction of at least 25% of their previous interest — with the seller ending up not connected with the company. A clean exit of an entire holding usually satisfies the substantial reduction test easily. It is the trade benefit test and the five-year holding period that catch people.

You can apply to HMRC for advance clearance on the treatment before completing. Do it. It is a letter, it takes weeks rather than months, and it converts the single largest variable in the deal into a known fact before anybody signs.

Where the cash problem bites

Take an illustrative company: two 50/50 founders, one leaving, agreed price £120,000. Distributable reserves are £74,000. Cash in the bank is £96,000, of which £31,000 is VAT and corporation tax owed but not yet due.

The company cannot buy the shares outright — not enough distributable reserves — and even if it could, paying £120,000 in cash would leave the business unable to meet its own tax bills. And instalments are not permitted.

The standard answer is a multiple completion contract: a single contract under which the shares are bought in tranches, with each tranche paid for in full in cash at its own completion date. The seller gives up beneficial ownership of all the shares at the outset and loses the associated rights, but is paid over time. HMRC has published its view on how these are treated, and the capital treatment analysis is applied at each completion. This is an area where specialist advice is genuinely worth what it costs, because the sequencing determines the tax.

The other lever is time. A company £46,000 short of the reserves it needs and trading profitably is often one or two decent quarters away from being able to do the transaction cleanly. Agreeing the price now, documenting it, and completing in tranches as reserves build is unglamorous and frequently the right answer.

What we would do differently

Almost everything painful about a founder exit is decided years earlier, in a document nobody wanted to write on day one.

A shareholders' agreement with a valuation mechanism — a formula, or a named independent valuer, or a multiple of a defined earnings measure — removes the single most corrosive argument. Without one, both sides arrive with a number they believe is obviously fair, and the gap between those numbers is where relationships end.

Good agreements also cover what happens on departure: whether shares must be offered back, at what price, whether a leaver who resigns is treated differently from one who is ill, and how long the company has to pay. None of that costs much to write while everyone still likes each other. All of it costs a great deal to negotiate afterwards. It is the same lesson as the co-founder agreement nobody wrote, arriving from the other direction, and the practical checklist is in what actually goes in a shareholders' agreement.

The other thing worth saying plainly: an exit funded by the business is money not spent on the business. £120,000 leaving over eighteen months is £120,000 not spent on hiring, equipment or working capital. Sometimes that is obviously worth it — a disengaged co-founder with a veto is a genuine drag on decision-making. But run it as an investment decision with a return attached, the same way you would run any other use of the company's money, rather than purely as a way to end an awkward situation.

Common questions

Can a company buy back shares in instalments?

Not directly. The Companies Act requires shares bought back by a company to be paid for in full, in cash, at completion, so a simple deferred payment arrangement is not permitted. The standard workaround is a multiple completion contract: one contract under which the shares are purchased in separate tranches, each with its own completion date and each paid in full at that point. The seller gives up beneficial ownership of the whole holding at the outset. The tax analysis is applied tranche by tranche, so the drafting and sequencing genuinely matter, and this is a transaction to run with a corporate solicitor and a tax adviser rather than from a template.

Will a share buyback be taxed as a dividend or a capital gain?

The default is a distribution, taxed on the seller at dividend rates — 10.75% basic and 35.75% higher rate from April 2026, with the additional rate at 39.35%. Capital treatment under section 1033 of the Corporation Tax Act 2010 applies instead where the conditions are met: the purchase benefits the company's trade and is not for tax avoidance, the shares have been owned for at least five years, and the seller's interest is substantially reduced by at least 25% with the seller becoming unconnected with the company. Capital gains tax rates are 18% and 24%, or 18% under Business Asset Disposal Relief from 6 April 2026. You can request advance clearance from HMRC.

What if the company does not have enough distributable reserves?

Then it cannot fund the buyback out of profits, and the options are to wait until reserves build, to purchase out of capital, or to restructure the deal. A private company can buy back shares out of capital up to a de minimis of £15,000 or 5% of share capital a year, whichever is lower, if the articles allow it. Beyond that, purchasing out of capital requires a directors' solvency statement, a report from the auditors, a special resolution and public notice to creditors. Many companies instead agree the price now and complete in tranches as reserves accumulate, which is slower but considerably simpler.

Do we have to tell Companies House and pay stamp duty?

Yes to both. Form SH03, the return of purchase of own shares, must be filed with Companies House within 28 days of the shares being delivered to the company. Where the consideration exceeds £1,000, stamp duty at 0.5% is payable to HMRC first, and Companies House will not accept the form until HMRC has confirmed the duty is paid. On a £120,000 buyback that is £600. The register of members must also be updated, the shares cancelled or held in treasury, and the resolutions kept with the company's records. These are cheap steps that invalidate the transaction if missed.