Exiting your business – The importance of forward planning
Establishing an exit strategy from your business can start at any time and is an essential element of your long-term financial strategy. Planning allows you to remain in control of the process and ultimately achieve the best possible deal.
When planning your own exit strategy there are some key issues to consider, including:
Passing on your business to your children or other family members, or a family trust
Selling your share in the business to your co-owners or partners
Selling your business to some or all of the workforce
Selling the business to a third party
Public flotation or sale to a public company
Minimising your tax liability
What you will do when you no longer own the business
Whether the new owners will need or desire your involvement after the sale
Selling the business
If your business has a market value, or you are relying on your business to provide you with a lump sum on sale, it is important to start planning as soon as possible. This is especially important if you are realising the value of your business within the next few years and want to maximise the net proceeds from its sale.
You will need to consider:
the timing of the sale
the prospective purchasers
the opportunities for reducing the tax due following a sale.
Maximising the value of your business
Whoever buys your business will want to have a clear view of the profitability – is it on the increase or decrease? Up-to-date management accounts and forecasts for the next 12 months will be vital pieces of information which should be available to prospective purchasers.
The potential value of the businesses is driven by the historical profits, an upwards trend in profitability should result in an increase in the business’ value.
Increasing profitability is always important but no more so than in the years leading up to the sale. Although you may think you can make an educated guess to the value of your business, a professional valuation is advisable. A potential purchaser may ask:
Are sales declining, flat, growing only at the rate of inflation or exceeding it?
Are stock and equipment a large part of your business’s value, or is yours a service business with limited fixed assets?
To what extent does your business depend on the health of other industries/the economy?
What is the outlook for your line of business as a whole?
Are your business’s products and services diversified?
How up to date is your technology?
When should you sell?
It is important to consider several factors when deciding on the best time to sell your business.
Personal factors could include when you plan to retire, health issues, life goals and if your income stream/wealth will be adequate post sale.
Business factors are also important in the timing of your sale. Selling at a time of economic growth means buyers outnumber sellers – ultimately resulting in the sale securing the best possible price. Other factors to consider include the current state of the stock market, the trend in the market for your type of business, if the business is forecasting upward trends and how successful the business is compared to its competitors.
The Treasury Select Committee recently announced they are considering increases to CGT rates. These changes may be a factor in bringing forward the sale of your business.
Minimising the capital gains tax
Taxes are an unavoidable aspect of a business owners’ life. When you finalise the sales agreement and take the proceeds from the sale of your business you will be completing one of the last steps in a strategy aimed at minimising the capital gains tax (CGT) and maximising the net return.
As a basic rule, CGT is charged on the difference between what you paid for an asset and what you receive when you sell it, less your annual CGT exemption if this has not been set against other gains. There are several other provisions, which may also need to be factored into the calculation of any CGT liability.
CGT reliefs can reduce a 20% CGT bill significantly. To maximise your net proceeds, it is vital that you consult with us about the timing of a sale, and the CGT reliefs and exemptions to which you might be entitled.
Calculating your CGT liability
The taxable gain is measured by comparing net proceeds with total cost (including costs of acquisition and enhancement expenditure).
The rate of tax depends on your overall income and gains position for 2021/22. Gains will be taxed at 10% to the extent that your taxable income and gains fall within the upper limit of the income tax basic rate band and 20% thereafter. These CGT rates are increased to 18% and 28% for ‘carried interest’ and gains on residential property.
A special tax relief, Business Asset Disposal Relief (BADR), is available for those in business, which may reduce the tax rate on the first £1 million of qualifying lifetime gains to 10%. This is targeted at working directors and employees who own at least 5% of the ordinary share capital of the company and the owners of unincorporated businesses.
The relief is available to individuals on the disposal after two complete qualifying years of:
all or part of a trading business carried on alone or in partnership
the assets of a trading business after cessation
shares in the individual’s ‘personal’ trading company
assets owned by the individual used by the individual’s personal trading company or trading partnership where the disposal is associated with a qualifying disposal of shares or partnership interest.
5% rules for company shareholders
To qualify for BADR, the company needs to be an individual’s personal company where the individual must:
be a company employee or office holder
hold at least 5% of the company’s ordinary share capital; and
be able to exercise at least 5% of the voting rights.
They must also satisfy one of the following tests:
a distribution test – an individual is entitled to at least 5% of the company’s profit available for distribution to equity holders and 5% of the assets available for distribution to equity holders in a winding up; or
a proceeds test – an individual is entitled to at least 5% of the proceeds in the event of a disposal of the whole of the ordinary share capital of the company.
All planned transactions require scrutiny to ensure that the available BADR is maximised.
Investors’ Relief (IR) also provides a 10% rate with a lifetime limit of £10 million for each individual. The main beneficiaries of this relief are external investors in unquoted trading companies.
There has been speculation that BADR may be phased out or eliminated in the future. It has already been significantly scaled back since the original Entrepreneurs Relief was introduced. This means gains would instead be taxed at 20%. If capital gains tax rates were brought in line with income tax rates, the top rate applying would be 45%, a significant increase on the current position.
EIS and similar investments
A gain on any disposal can be deferred by investing in shares under the EIS scheme. Similar relief is available to investors in shares under Seed EIS (50% maximum) and to those investing in or leading to qualifying social enterprises under SITR. This delays the tax due on the original disposal but does not eliminate it.
However, the CGT treatment of gains on EIS shares themselves is very advantageous, and this might be an area worth considering.
CGT and non-residents
CGT is normally only chargeable where the taxpayer is resident in the UK in the tax year the gain arose, although the provisions of any double taxation treaty need to be checked. CGT may be avoided, provided the taxpayer becomes non-UK resident before the disposal and remains non-resident for tax purposes for five complete tax years.
CGT and death
There is no liability to CGT on any asset appreciation at your death.
Inheritance tax (IHT) and your business
For the business owner, the vital elements in the IHT regime are the reliefs on business and agricultural property of up to 100% of the value, which continue to afford exemption on the transfer of qualifying property, or a qualifying shareholding. Ask us to check whether your assets come within this exemption.
Transfers on your death
Do not overlook your business when you draw up your Will. Reliefs may mean that there is little or no IHT to pay on your death, but your Will is your route to directing the value of your business to your chosen heir(s) unless the disposition of your business interest on your death is covered by your partnership or shareholders’ agreement.
How we can help
Planning for the potential sale of a business should be undertaken in good time, and ideally three years before any disposal. However, given the likely changes to CGT rates and the potential elimination of BADR this may be something you want to start thinking about sooner rather than later.
However you plan to exit your business, LK & Associates has the specialist knowledge to help you minimise your liability to tax and help you through this complex area.