At the start of 2021 there were 5.5 million small businesses, but this was down by 6.5% on the previous year[i]. Retiring is one of the most common reasons for selling a business, and after the challenges of dealing with the pandemic, many business owners may wish to retire and sell during 2022.
For some who have had their business for many years this can be an emotional and complex task. It can be difficult to know where to start, and it’s something most will need help with as there are many important legal and financial considerations.
They will need to ensure their company is financially stable and that the profit from the sale will be enough to give them the retirement they have always dreamt of, as well as take care of their loved ones.
One of the first things business owners should do is to spend some time planning the process and understanding what it entails at each stage of the sale.
Duncan Macpherson, Chartered Financial Planner at Punter Southall Wealth recommended one approach; consider three simple questions that are aligned to key stages of the business ownership lifecycle as they will provide useful and important insights for their plans.
Will I be able to make my money last?
During the initial pre-sale stage, it’s all about getting the business in the right shape. This is the time to engage a solicitor to ensure that their Articles of Association are up-to-date, employment contracts are in place and any health implications that could affect the seller are taken into consideration. It is also important that wills and Lasting Powers of Attorney are in place, and even keyman insurance and directors’ shareholder protection.
When someone is looking to sell, the primary concern is losing their main source of income. Many are also concerned about the size of their pension pot, with research last year suggesting 45% of small business owners are expecting to outlive their retirement funds[ii].
Therefore, it’s essential to understand how much money from the sale is needed to achieve all their plans, especially if they were relying on this to fund their retirement. Understanding their current lifestyle and what plans they may have for the next chapter is crucial, and this is where the services of a financial planner can prove invaluable.
Cashflow modelling and budgeting forms an integral part of this process, as it can help business owners understand where they are and helps them better visualise the future. This can provide useful insight into how much they might need. It may show that they could sell for less, or earlier, and still be comfortable, allowing them to make an informed decision when an offer comes in.
How will the sale of my business impact my tax position?
Moving onto the selling stage it’s important, prior to the sale, to ensure that all tax allowances are used such as maximising pension contributions and carrying forward any contributions that exceed the annual allowance and still benefit from tax relief. This may be an opportunity to reduce cash held on the balance sheet.
Capital Gains Tax (CGT) may need to be paid on any profit. This can include anything involved with the business, such as land and buildings, machinery and even shares, but it may be possible to reduce the potential tax bill using Business Asset Disposal Relief (BADR).
To qualify for BADR, which replaced Entrepreneur’s Relief in 2020, a business must have been owned for at least two years. If applicable, BADR can be used to reduce the CGT owners pay on qualifying assets down to 10%. This can be applied to the value of the business and its assets up to a lifetime threshold of £1 million.
Any gains that don’t qualify for BADR, or are above the £1 million threshold, will be charged at 10% or 20% for higher rate taxpayers, subject to any annual exempt amount and depending on the availability of the individual’s basic rate band.
Once all taxes have been covered on exit, it is now time to transition business owners from the world of Corporate Tax to Personal Tax.
Post sale, the role of a financial planner is to ensure that all allowances are used to provide the most tax-efficient income in retirement. If we take a married couple, for example, then we have two sets of allowances to work with, covering their personal allowances, dividend and savings allowance in addition to annual capital gains tax exemptions and potentially tax-free cash entitlement from pensions. When looked at in combination, the gross income required to achieve the desired net income in retirement, may not need to be as high as they may think.
Another tax to consider is Inheritance Tax (IHT). Once the business is sold, all the proceeds, without any planning, would normally fall back into their estate for tax. Although we can often arrange life policies in trust as a useful way of providing liquidity in the short term, we work with our clients to make longer term plans for this, with a range of options including qualifying reinvestments and gifting, either outright or into trusts.
Can I take care of my loved ones and live the kind of retirement I would like?
Once the sale is complete, the post-sale stage involves structuring investments to make sure they provide the level of income required to maintain a client’s desired lifestyle. One key element of this is establishing their ‘attitude to risk’. At this point it will be based upon how much risk they need to take rather than the risk appetite they had when building their business.
Cashflow modelling will support this part of the journey too. This is the time when they may consider gifting, whilst at the same time securing their future needs. Ongoing financial and legal advice is important as there may be changes in circumstances, legislation, and investment markets, which must be considered, year on year.
One of the most common business sale pitfalls is failure to plan ahead. Taking the above approach will help business owners avoid this as they will have considered and planned every stage. They shouldn’t do this alone and collaborating with solicitors and other professionals, and using their specialist services, is vital to working through the stages ensuring the very best outcome for their retirement.
Duncan Macpherson, Chartered Financial Planner, Punter Southall Wealth
Duncan.Macpherson@puntersouthallwealth.com
[i] https://www.fsb.org.uk/uk-small-business-statistics.html
[ii] https://startups.co.uk/news/entrepreneurs-could-outlive-their-retirement-funds/