The importance of planning a retirement exit strategy is all important for business owners. Adrian Shandley goes through the different options available to ensure a smooth progression
Some years ago somebody said to me "Everything has a natural life, it is important to realise when the natural life is over and move on." This is true of everything; but is especially true for owners of small businesses.
When you have given a large part of your life to a business it is quite understandable that you are reluctant to let go of the reins and retire. However, failure to recognise the fact that the time has come for a business owner to step down and hand over the business can be a very damaging mistake.
People who go on too long running businesses become ineffective; they are less able to change in response to the market and innovation. Often this can lead to the stagnation or decline of a previously successful enterprise.
Recognising that it is time to retire is one thing, having a viable option to retire is quite another. Business owners have often been too busy working 'in the business' and have forgotten to work 'on the business' and make their succession plans.
The recent changes in capital gains tax will have a far reaching effect on those retiring from a business or company and the taxation burden is undoubtedly going to increase. With the abolition of taper relief and indexation allowances, this government has managed to achieve something that no other government has attempted, in that they are effectively taxing inflation. No longer are we allowed to raise the original purchase price of an asset or a business in line with inflation before the taxable gain is calculated.
There has, however, been one concession to the owners of small to medium sized businesses, and that is the fact that the government has allowed entrepreneurs to claim 'entrepreneurs relief'.
Entrepreneurs relief allows individuals to claim up to £1,000,000 of taxable gains at a rate of 10% taxation. When the abolition of taper relief and indexation is considered, this still represents a hefty rise in the tax payable on the first £1,000,000 of gains. Furthermore, this allowance is a lifetime allowance and does little to help the serial entrepreneur. Gains over £1,000,000 will be taxed at a flat rate of 18%, but it is my suspicion that this is just an initial starting rate of tax and the 18% figure will rise in future years as the budget deficit gets worse.
So, it has never been more important to plan your exit from your business, but the exit routes are fraught with problems.
One of the most common examples is a family run business which is structured as a partnership, often employing a number of close family members. One of the biggest mistakes that entrepreneurs make is assuming that their children will have the same flair for business that they do. In the majority of cases this is simply not the case and children are often found to have much less business acumen than perhaps their parents did. This in itself can cause serious problems for the business owner who wants to hand his business to his children and still continue to draw an income; effectively a 'pension'. Most parents do not want to charge their children large amounts of money to buy the family business because it would result in financial hardship for the children (servicing the loan) and compound any inheritance tax problem on the estates of the parents.
It is all well and good handing over the reins of the family business to the children, assuming an income will be paid to you for the long term, but what happens when the children mismanage the business, resulting in your 'pension' disappearing?
All too often business owners have been too busy to look after their own financial affairs because the bulk of their time has been spent building up their business. All too often there simply hasn't been the money to pay into pensions during a working lifetime, and all too many people consider that "my business is my pension". So the method of disposal or sale of the business can have serious long term consequences.
If the business is not a family concern and the children are not interested in taking over the business, then in most cases a sale or merger is the best route, but in either case this has to be planned a good number of years ahead of the intended total retirement date. With a sale or a merger it is common for the new owners to insist on a period of consultancy to ensure a smooth transition and hand over.
A good way to expand your business is to purchase the competition and so for a prospective seller a good option is to confidentially talk to your larger competitors about the possibility of a buyout. In the case of a buyout or merger there are many different ways to sell your business and many different ways in which you can be paid. Many business owners prefer a one off lump sum payment, assuming it suits their tax position. A one off upfront payment, at least, means that your money is 'in the bank' and cannot be taken from you. If staged payments are to be accepted, it is very important to ensure that guarantees or debentures are in place to provide security of future payments. There is no point selling your business to somebody who cannot afford to pay you in the future; this is as bad as throwing your life's work away.
If the prospective purchaser is a large company, then loan notes are a very tax efficient option and allows the seller to realise the gain in a future tax year or tax years of their choosing. This may be in tax years when they are domiciled or not domiciled within the UK as the case may be and long term periods of absence from the UK can lead to exemption from UK capital gains tax rules.
One of the golden rules of selling your business to a competitor or an outside party is to ensure that you have accurate and comprehensive management accounting software, together with a good long term set of accounts produced by a reputable accountant. The price you sell your business for will ultimately be dictated by your financial information, do not neglect it.
For some owners of limited companies employee equity ownership is a route to encourage a future management buyout of the main shareholder. The government does currently offer favourable tax incentives for business owners who set up official share option schemes for employees. However, like the case of the family business being passed to the children of the founder, such schemes will only be as successful as the people who take over the business. Too much power to a key employee prior to the retirement of the owner also runs the risk of a coup or worse still, a defection and loss of key clients. The years leading up to retirement can be fragile and fraught with danger as you start to find yourself having to put high levels of trust in other people.
The need to plan
Although taxation planning may be severely restricted under this government, tax advice some years prior to your intended retirement date could be very valuable in the long term. A good proactive accountant is worth his weight in gold, but unfortunately, far too many accountants are reactive to figures supplied by the client. An accountant who tells you what you should be doing is far more valuable than an accountant who tells you what you did last year. A five year retirement plan, possibly incorporating serious pension contributions, can save a lot of money in tax and lead to a much more comfortable retirement for the sellers of small businesses.
Sometimes, due to the nature of the business or because of a declining or contracting market, the only option for a business owner when they want to retire is to cease trading or liquidate their company. This too can have tax advantages if structured properly, providing the company was financially strong at the point of cessation. Again, a good accountant can advise you properly on this side of things.
Finally, beware of the legal side of selling your business, especially if you are in a partnership with others. While there is a firm set of rules that the courts can apply to limited companies and shareholders, there are no such statutory rules in relation to partnerships, other than a very old and outdated partnership act. The vast majority of disputes come when a partner wants to retire from a business in which he trades with one or more other partners. There are no such things as friends in business, and when push comes to shove you are relying on the integrity of your other business partners to provide the money for your retirement from the partnership. This is often when true colours are shown!
For partnerships it is vitally important to ensure that you have a structured legal partnership agreement which gives a formula and procedure for retiring partners. This should be done initially when the partnership is formed.
However you decide to retire from your business, the key is planning ahead. Your natural life within your business will ultimately come to an end, as does everything. When you are retiring it isn't so much as recognising when the natural life is over, it is more a case of seeing it on the horizon and planning in advance.
Clarke replacing Balkham
'Deep-dive analysis of client behaviour'
Ways to mitigate April’s increases
The best equity income funds examined