This article is written by

Kerry McCaughan

Kerry McCaughan of Johnston Campbell looks at the four critical stages that business owners go through, as well as exploring how financial business planning can help.

Find out more about Kerry

Owning your own business is one of the most exciting, and some would say stressful, things that anyone will do. But while every business is unique, my experience of working closely with business owners has taught me that they tend to face a common set of challenges.

With this in mind, I wanted to explore the four key stages of business planning, and outline some key areas of financial planning to consider.

Every business will experience unforeseen events at some point

1. Protecting what you have

When a business is in its early stages, the number one priority for its owner (or owners) is usually to protect what they have.

Every business will experience unforeseen events at some point, but younger businesses are particularly vulnerable when an owner or key employee is suddenly unable to work. A ‘key person’ is someone whose knowledge, experience or leadership is integral to the future success of the business.

Fortunately, business owners in this phase have several protection options to consider. These include:

– Key person protection:

An insurance policy protecting against loss of revenue should the owner or a key employee die, or be diagnosed with a critical or terminal illness.

– Partnership or shareholder protection:

This policy is designed specifically to prevent someone in a business partnership from losing control of their business when a partner or major shareholder dies, or is diagnosed with a critical or terminal illness. The policy will provide funds to buy the interest in the partnership, either from the affected partner or from their estate.

– Business loan protection:

This policy will pay out a lump sum to repay a business loan, commercial mortgage, overdraft or a director’s loan if the business owner, key person or major shareholder dies, or suffers a critical or terminal illness.

These policies are designed to help the business recover quickly and keep going, should the worst happen. Putting plans like this in place can give business owners peace of mind, leaving them free to concentrate on growing the business and developing a business culture that makes it a truly rewarding place to work.

It’s well worth taking advantage of the tax relief available on pensions as early as you can

2. Profit extraction

Once the business has started generating profits, business owners will begin thinking about how best to extract them – preferably as tax-efficiently as possible.

If the business is a limited company, there are usually three main routes through which the business owner can extract profits:

— salary,
— dividends, and
— pension contributions

The alternative option (explored later), is to leave the profit in the company and then take the proceeds once it’s sold. But if you’re looking for the most tax-efficient way to extract profits, and you don’t need immediate access to the funds, it’s hard to look beyond a pension.

– Pensions

Pensions are even more tax-efficient for business owners because the pension contributions are paid out of pre-tax company income.

Therefore, for every contribution made by the company, the full amount is added to the employee’s pension, without Income Tax, National Insurance or Corporation Tax payable. Plus, all pension contributions are topped-up by an additional tax-free contribution from the government.

For example, a higher-rate taxpayer in Northern Ireland, Wales or England making a pension contribution of £6,000 will have their pension topped up by an additional £4,000, taking their total contribution to £10,000 (people in Scotland pay different tax rates, so the pension tax relief calculation is slightly different).

For most individuals, the maximum annual pension allowance (the amount they or their business can pay into their pension each year) is capped at £40,000. Any contributions over that amount will have the tax relief withdrawn – although any unused allowance from the previous three tax years can be used up.

Also, the annual pension allowance is tapered for high earners, including business owners and the self-employed. So, anyone earning an income of more than £240,000 will have their annual pension allowance reduced by £1 for every £2 of income.

People often baulk at the idea of paying into their pension because they think they won’t get to enjoy the money until they retire. However, pension freedom rules, introduced back in 2015, mean you can take up to 25% of your accrued pension as a tax-free lump sum from the age of 55. That means it’s well worth taking advantage of the tax relief available on pensions as early as you can.

It’s important to remember that pension planning can be complicated, and that HMRC tax rules are complex and can change at short notice. For this reason, it’s important to get professional financial planning advice before making any decisions.

– Tax-efficient investments

For business owners who have reached their annual pension allowance threshold, it’s worth considering other tax-efficient investments such as venture capital trusts (VCTs).

A VCT is an investment company created to invest in small (usually unlisted) UK businesses. Because these are ‘early-stage’ businesses, investing in them is much riskier than investing in larger, well-established businesses listed on the FTSE, for example.

To compensate for this higher risk, VCTs come with several tax advantages. For example, investors can claim up to 30% income tax relief on up to £200,000 invested in any single tax year, provided the VCT shares are held for at least five years. Any dividends paid by the VCT are also tax-free, and there is no Capital Gains Tax (CGT) due when the investor chooses to sell their VCT shares.

VCTs used to be considered niche investments, but since the annual pension allowance was introduced, they are increasingly being used as part of mainstream retirement planning.

While they shouldn’t be considered as a pension replacement, they can be a useful complementary tax-efficient investment. This is particularly true of those business owners who would like to reduce their Income Tax bill and are comfortable with the risks associated of investing in early-stage companies. That’s because the value of pensions and any other investments, and any income you take from them, can fall as well as rise, and you may get back less than you invested.

It’s important to have confidence that the business you’ve worked so hard to build will be left in the right hands

3. Succession planning

One of the most challenging, and emotionally complex, phases of a business’ lifecycle involves succession planning. Deciding what will happen to your business if you need to step away, decide to retire or are simply no longer around can be a painful process. And while there are no right or wrong answers, talking to a financial business planning professional about your plans can help you to make the best decision based on your personal circumstances.

For example, if you want the business to be passed on to your children, putting a shareholders’ agreement in place – preferably as early as possible – could help settle any potential family disputes that could occur further down the line.

If you want to choose another business successor, perhaps someone already working in the business, you may decide to sell your stake in the business completely. At this point it’s important to consider the amount of CGT you might have to pay upon sale.

It’s also important to have an understanding of Business Asset Disposal Relief (formerly known as Entrepreneur’s Relief), which could entitle you to pay CGT at a reduced rate of 10%, compared to 20% on gains from chargeable assets.

Change can be difficult for everyone involved. Whatever you decide, it’s important to have confidence that the business you’ve worked so hard to build will be left in the right hands. Being proactive with your business succession plans will help to ensure you get to make the choices on your terms, not anyone else’s.

Ensure you have enough for a comfortable retirement, and to look after your children and grandchildren

4. Inheritance and estate planning

The fourth stage business owners need to consider involves the thorny issue of Inheritance Tax (IHT).

Most business owners want to not only ensure they have enough money for a comfortable retirement, but also enough wealth accumulated to look after their children and grandchildren. At this point, we can look at ways to ensure their accumulated wealth stays in their control, without triggering a large IHT bill for their family to deal with when they pass away.

As well as helping with gifting strategies, the arrangement of trusts, and life assurance policies, a financial business planning professional can offer advice on investments that are designed to reduce or eliminate a large IHT bill. This can be particularly beneficial for business owners sitting on large cash sums after selling their business.

For example, if the business qualifies for Business Relief (BR), this will no longer apply once the business is sold. Business Relief was introduced to make it easier for business owners to pass their business down from one generation to the next, without leaving the business owner’s estate facing a large IHT bill. However, after the business is sold, the proceeds of the sale will once again be eligible for IHT.

In these situations, it can make sense to look at specialist investment vehicles that invest in companies qualifying for BR, meaning the investment vehicle is free from IHT. The advantage of this process is that the investment becomes free from IHT immediately, provided the proceeds of the business sale are invested within three years. This could be particularly important if the business owner has been forced to sell due to ill health and time is a factor.

Financial business planning with Amber River

Business owners often approach life with the belief that they need to make everything happen on their own. But when it comes to making important strategic decisions about the future of your business, you don’t need to do it yourself.

Amber River financial planners work alongside accountants, tax planning professionals and solicitors on behalf of business owner clients, because a joined-up approach is usually the best solution.

Kerry explains “One of the most rewarding aspects of the job is working with clients at each business stage, helping them to protect what they have, take their business to new heights and then, when the time is right, using it to achieve the lifestyle (and the legacy) they want.”

Whatever stage your business is at right now, get in touch. We would love to see how we can help take you further.

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