Succession planning for small companies: How to protect the value of the business you built
There are more small businesses in the UK today than ever before but far too many are failing to protect themselves against the two biggest risks they face, writes Tom Conner, director of financial advisors Drewberry.
Britain has become a nation of small business owners. At last count, there were almost 5.5m SMEs in the UK with an estimated turnover of 1.8tn per annum (getting on for half of all private sector turnover in this country).
But while we have a great tradition of creating vibrant new businesses in this country, our track record of protecting those enterprises still leaves a lot be desired.
The first problem, namely succession planning, can be addressed with what’s called shareholder protection insurance. don’t make the mistake of thinking this is somehow for older people. it’s never too early to start thinking about succession issues.
Remember that having a decent shareholder protection arrangement in place is the only reliable way to ensure both the continuation of your business in its current form after you’ve gone and that the families of those who built the business (yours included) are adequately rewarded for all that hard work.
With no formal arrangement in place, when a shareholder dies, their shares will pass to their next of kin. But a “like-for-like” swap among family members isnt likely to improve the position for a company that’s just lost one of its founding shareholders.
Meanwhile, most family members who inherit private company shares want nothing so much as to “move on” with a lump sum that fairly reflects the years of hard work it represents. For them, the worst thing that can happen is to be “frozen out” with a pile of shares they can’t sell and that the remaining shareholders have neither the means, nor the motive, to purchase.
In case of emergency…
A raft of shareholder protection policies provides both the means and the mechanism to enact a smooth, tax-efficient transfer of a director’s shares in the event of their death or ill health. it’s just a series of individual life, and possibly critical illness, policies on each shareholder, each of which is written in trust for their fellow shareholders.
However, there are quite a few hoops to jump through. This means it’s well worth engaging a business protection adviser who can help you over the main hurdles, the first of which is usually the valuation.
Insurers will require that your valuation of the business can be justified, which often means that the valuation is based on a “reasonable” EBITDA/profit multiple. For very early-stage businesses/startups some insurers may consider a revenue multiple instead.
Youll also need to put a “cross-option agreement” in place (and a “single-option agreement” if your policies cover serious illness), which specifies that if the heirs wish to sell the shares, the business must buy, and vice versa. The wording is important here as if they lose what HMRC describes as their “commerciality” they risk being assessed for inheritance tax. Youll also need to ensure that the premiums are “equalised” something else your adviser can talk you through or you risk falling foul of the same rule.
In a nutshell, a shareholder protection arrangement provides both the means and the mechanism for the shares of a deceased shareholder to be bought by the remaining shareholders from the deceased shareholders family. This ensures the existing shareholders retain complete control of the business and the family of the partner that passed away are financially compensated in full for those shares.
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