Selling or passing on your business might seem like a natural next step in your life. Yet business succession can be fraught with challenges, from
the impact of losing the founder to the potential for family infighting. There is also an intricate web of tax obligations to manage. In this series on the Great Wealth Transfer Jonathan Gain, CEO of Stellar Asset Management, looks at how to prepare for successful business succession without the headaches and costly tax hits.
You can be justifiably proud of the thriving business you have created. Yet, there will come a time to hand over the reins. You might want to pass on the running of the company to one of your children. Alternatively, you might want to sell the enterprise or your share in it so you can step back, spend more time with your family and enjoy some of your hard-earned wealth. When the succession comes, you will naturally want to realise the full financial rewards for all your ingenuity, innovation and hard work. There is also a significant amount of emotional value wrapped up in your cherished business. You want to make sure it is in good hands – transition smoothed, employees taken care of and a bright future ahead.
What to look out for
The big risk is failing to properly prepare for what is a highly challenging next step in your life from a business, financial and family perspective.
Business challenges
The main business issues centre on what happens when you have gone. Could the loss of you as the founder, driver and public face of the company impair its value? Who is going to take the helm – a chosen successor within your family or one of your management team? How can you ensure continuity during the handover?
Financial challenges
If you are selling, the immediate financial challenge is how to secure the best price. Yet, this is only part of the story. Some of the trickiest financial issues centre on the tax implications, which could wipe out a huge amount of the value built up in your company.
Profits from a sale could be subject to capital gains tax (CGT). If you are a sole trader or business partner, you may be able to reduce the CGT rate by claiming business asset disposal relief (formally known as entrepreneur’s relief)
However, the relief only applies to trading activities rather than investments such as property holdings. If your cash reserves are more than you need to meet your working capital needs, these may also be classed as investments.
The other big consideration is inheritance tax (IHT).
If no reliefs apply, IHT is charged at 40% on the value of your estate, which could place a substantial financial burden on your beneficiaries and their ability to manage the company.
Even if you sell the company before you die, the proceeds would still be part of your estate and subject to IHT.
Family challenges
The family challenges centre on the expectations of your various beneficiaries and the relationships between them. You may be planning to keep the business in your family, but some children want to be involved, while others do not. How can you square the different ambitions – appropriately rewarding children who want to be part of the business, while not neglecting the others? The potential for disputes can be exacerbated by sibling rivalry or divisions with your family.
Three ways to secure successful succession
The good news is there are a range of powerful and versatile tools to manage the challenges and secure the best outcome for you, your family and your business. Three priorities stand out:
- Tailor the solution
Solutions can be closely tailored to the specific circumstances of your business, the dynamics within your family and what you want for the future. In a case in point, what if your daughter wants to take over the running of the business but your son has other life plans. If so, a possible option is to set up a trust that gives your daughter control of the enterprise and a higher share of the financial benefit, while your son still receives some dividend income from the company.
The right structures can also take out some of the potential headaches. For example, if you jointly own the business with other major shareholders, the company can take out insurance or set up a cross option that would allow your fellow owners to buy your share from the estate in the event of your death. The solution protects your family’s financial interests while ensuring continuity and control within the company.
These are just a snapshot of the many and varied solutions on offer. The key point is that the permutations and your ability to fit them around your aspirations are virtually limitless. - Align succession with tax and estate planning
Just as the right structuring can square business and family priorities, it can also ensure a tax-efficient exit and estate planning. An increasingly popular option for owners who want to pass the business to their children while limiting their tax liabilities is a family buy-out.
A family buy-out allows you to sell a proportion or all of your business to a company set up for this purpose by your children (NewCo) in return for a loan note. For example, if you sell 50% of your company to the NewCo, half of the future growth accrues to your children. You retain the other half of the shares, so can continue to have a strong say in the running of the business as part of a phased succession.
If one or more of your children want to take an active role in your company, they can receive voting shares in the NewCo, plus a salary and dividends, while siblings who do not want to be involved can be given nonvoting shares and a preferential dividend. From a tax perspective, the repayment of the loan note has the advantage of being charged at CGT rather than the higher dividend rate. The 50% in the NewCo is also now outside your estate, which would lower your IHT liabilities. If none of your children want to take on the running of the company, a trade sale is an obvious option. In the interests of business continuity, you might also consider a traditional management buyout (MBO) or sale to an employee ownership trust (EOT). EOTs enable employees to take a stake in the business, while offering owners potential relief from CGT.
With proceeds from the sale banked, the next big consideration is how to make sure that your beneficiaries are not left with a 40% IHT bill. Possible options include a gift or lifetime trust. However, these need to be in place for at least seven years to be IHT free. They also come with a lot of restrictions and legal costs. A generally faster, more flexible and less complicated alternative to gifts and trusts is Family Trading Companies. By investing in assets qualifying for Business Relief, your family’s capital can be IHT free in two years. Further advantages of Family Trading Companies include meeting the different financial goals of all the various members of your family. Each beneficiary can be the sole shareholder in a company specifically set up to meet their particular objectives and investment preferences. - Allow enough time
As an entrepreneur, you are more likely to be focused on the immediate challenges of running and growing your business than thinking about succession. Yet, time is your best ally in preparing for the future. In seeking to maximise the valuation of your business, you may need to allow time to turn new products and other business developments into revenues. You also need time to prepare performance data, asset valuations, revenue projections and other key numbers needed to support the sale. The more the potential buyer knows about your company, the better he price they will be prepared to offer. Crucially, early planning can also make it easier to balance the different interests and expectations within your family, while putting in place the solutions needed to reduce your tax liabilities.
