Plan early when exiting a business

Two out of five business owners in the UK are planning to sell, wind up, or crystallize assets within the next year. According to a recent poll conducted by Censuswide, 40% of the 504 surveyed business owners with revenue exceeding £5 million expressed their intention to exit within the next year. Additionally, 23% of UK business owners have expedited their plans to sell or wind down their businesses in the past 12 months.
 

The reasons often cited for these decisions include potential changes in the government, difficulties in accessing capital and investments, changes to the tax regime, and inflation. Undoubtedly, concerns about the future political landscape have prompted some business owners to contemplate an early exit. Setting politics aside, there are actions that business owners can take prior to exiting to facilitate their long-term succession planning.

Advice and options for business owners on exit strategies
 

An exit strategy should involve two distinct types of advice. Firstly, advice from a business perspective as part of the sale process, and secondly, important but often overlooked advice regarding the owner's personal position and succession plans. Neglecting to consider their own situation may cause business owners to miss out on opportunities to capitalize on potential reliefs that can reduce the overall tax burden on themselves and their families in the future.

Generally, two options are available for exiting a business: selling the business (to private equity, through a trade sale, or by way of a management buy-out or employee ownership trust) or passing the business down to the next generation of the family. The chosen route will depend on individual goals and may be guided by the owner's future aspirations, such as generating income, generating capital, or planning for succession. Business owners need to consider how much they personally require to maintain their lifestyle, whether they want to transfer wealth to family members, and what their long-term succession goals are.

Tax considerations for business owners 

The tax challenge often lies in minimizing the impact of capital gains tax ("CGT") when exiting the business and determining whether Business Asset Disposal Relief ("BADR") (formerly known as Entrepreneurs' Relief) will be available on the sale. Another significant challenge, with potential repercussions, is the impact of Inheritance Tax ("IHT").

CGT is typically charged on the gain in value of assets, with a maximum rate of 28% or a more typical rate of 20%. However, when a person disposes of an interest in a business, BADR can reduce the CGT rate to just 10%. There are specific rules that must be met to claim BADR, and although the relief has been reduced from £10 million to £1 million, it can still result in efficient savings. Carefully restructuring the ownership of the business before the exit may allow for maximizing CGT and BADR savings. For example, shares could be transferred to a spouse prior to the sale with no immediate tax consequences, enabling them to utilize their own CGT relief.

Managing Inheritance Tax and Planning for Succession
 

The other aspect of exit planning to consider is the impact of IHT on the proceeds of the sale. It is essential to carry out succession planning both before and after the exit.

Normally, trading businesses qualify for Business Property Relief ("BPR"), exempting them from IHT, provided certain conditions are met. If the business is retained and the BPR conditions are met, the entire business may pass to the next generation without incurring IHT. However, cash proceeds from the sale are immediately susceptible to IHT, meaning up to 40% of the estate above the available nil rate band tax-free amount will be subject to IHT. Therefore, planning prior to the exit is essential.

Strategies for wealth transfer and tax optimisation
 

Business owners often plan to use the funds to benefit their children or extended family, invest in a new business, or fund their early retirement. It is crucial to carefully consider the impact of losing BPR and the potential consequence of having excessive funds, which would increase the value of the estate subject to IHT.

If a business owner knows in advance that they want to benefit future generations by a specific amount, it is usually more advantageous to transfer a shareholding worth that value before the exit. This can be done by gifting the shares to the relevant individual, so when the business is sold, the cash would be held by that shareholder. If certain requirements are met, the cash will be outside the business owner's estate for IHT purposes.

Alternatively, gifting the shares to the trustees of a family trust effectively moves the value outside the estate. Trusts have the additional advantage of providing protection against financial threats such as divorce, misuse, and bankruptcy, while allowing the business owner to retain control of the shares/funds. When the business is sold, the cash value would be held in a trust outside the business owner's estate for IHT and can benefit future generations while ensuring control remains with the older generation. There is no immediate charge to IHT provided that the shares qualify for BPR.

Particularly careful advice is required to ensure that BADR, CGT planning, and IHT planning all align smoothly, as the combination of reliefs offers both opportunities and potential pitfalls for business owners.

Once the business has been sold, it is imperative to continue with succession planning since the estate and IHT position will likely have significantly changed, regardless of any gifts made prior to the sale. Ongoing succession planning may involve further gifting, establishing family investment companies, or setting up trusts.

Separately but related, business owners should always ensure that their wills adequately address their business interests. Business succession presents unique practical challenges, as well as opportunities and pitfalls for tax savings. Considering what happens to the business upon death is essential, particularly if the business is being sold at that time.

The value of early planning for business owners
 

Exiting a business is a personal decision. Business owners devote years of hard work to build a thriving, profitable business, and it is evident that there is significant value in planning ahead and seeking early advice. The opportunity to plan diminishes as the sale approaches, so it's important not to leave it too late!

further information

If you have any questions or concerns about the topics raised in this blog, please contact Diva Shah or any member of the Private Client team.

about the author

Diva is an associate in the private client team. She acts for various clients including high net worth individuals, entrepreneurs, executors, trustees and individuals who lack mental capacity on a broad range of matters including, lifetime succession and estate planning and succession planning for companies (well established companies and start-ups).