Over the past two weeks I have been considering the very real challenge faced by those (many I suspect) owner/managers of small/medium enterprises (SMEs) who have total reliance, or at least overreliance, on their business as the means of producing financial independence or continued financial wellbeing in the future.
That is not to say that it never can. There are many spectacular success stories but these successes will have mostly come about because the owners were very focused and intentional about achieving their goals.
They will have had a very clear idea about what is needed to build reliable value in a business or what is needed to ensure that a business can remain vital and profitable without reliance on the owner(s). And let’s not forget, retaining a business that continues to yield profit without the day-to-day involvement of the current owner can represent a very real choice.
It does not always have to be about cashing out or, if you are Mickey Flanagan, cashing “out, out!” Even though the current CGT regime, delivering a 10 per cent CGT rate on “lifetime” qualifying gains of up to £10m, is pretty appealing you still have to then invest the proceeds to deliver the income and growth with the levels of risk you are prepared to bear.
Tax planning plays a key role here so as to minimise tax outflow and thus make the income or growth target easier to achieve.
On reaching a time when a decision needs to be made about the future of the business, and an appropriate strategy implemented, then if the one chosen, for whatever reason, cannot be executed there will be no contingency plan and the aspired-to outcome will not be possible.
An adviser must first establish which “financial future”, in relation to the business, the owners would most like to pursue. There are many variations on the theme but essentially they are all centred on selling or retaining the business. Essentially, for each of the possible “futures” in relation to the business, the associated risks, and how to financially protect against those risks, will need to be determined.
Sell the business:
Risk: No buyer, sale proceeds are insufficient or higher taxes seriously diminish available sum.
Allocate some current income to build tax-efficient contingency funds through:
- other appropriate savings vehicles
This will reduce dependency on the business and any resulting revenue dilution for the business (caused by this diversification) should not affect the value of the business if its value derives substantially from future profits. This is because if “risk-related outgoings”, eg contributions and premiums, cease or substantially reduce on sale – as they usually will – revenue and profit will be restored.
This is an important factor in overcoming objections to this kind of “diversification strategy” ie to remind owners that they will substantially be selling a future profit stream when the time comes.
Post sale, as well as planning tax-effective investment, a consideration of estate planning will also need to be built into the plan as a (likely) IHT-free asset (your business interest) will have been converted to an asset (cash/investments) that would be subject to inheritance tax.
Carry on working:
Risk: “Energy”/health fails or profits fall.
Tax-effective contingency fund (through pensions/Isas etc) to reduce reliance on business and facilitate possibly working less and taking less income. This strategy, supplemented by appropriate health, income protection and life assurance to provide an (affordable) level of additional sickness/death-related cover could work quite well dependent, of course, on cost.
Carry on working, but a bit less:
Risk: That business profits will fall without the owner’s full-time involvement.
Providing a tax-efficient contingency fund to allow less to be drawn from the business and supplement it with tax-efficient income from pensions, Isas and other appropriate investments.
Providing for the reduction of the potential “financial stress” on the business (of continuing to pay the owners at a time when they are not working full time) may mean that the planned outcome can be better achieved.
Essentially, all of these strategies need to accept and embrace the importance of the business as an “asset class” – while at the same time accepting that it should not be the only asset class in the investment strategy.
Inevitably, for those business owners who are “overrelying on their business” the first thing that the adviser needs to do is to professionally create “justifiable anxiety” over this fact. To do this it will be necessary to ensure, in a way that best resonates with the particular client, that the client “gets” the risk they are assuming by adopting a strategy of “overreliance”.
The adviser will need all of their powers of understanding and communication to articulate the risk and opportunity (to overcome it) in a way that will cause the client to take action.
Tony Wickenden is joint managing director of Technical Connection
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