Eventually, every owner leaves their business. Few, however, properly plan for succession or exit on their own terms.
It is never too early to start thinking about exiting your business. It is important to realise that exit planning is not a single event, but a tailored process. Even if you are not currently planning to exit your business, understanding the process will make it easier to maximise your financial return when you are ready to sell and/or retire.
It can take up to 5 years to become ‘investment ready’. A period of ‘grooming’ is therefore required to maximise value. Management should consider:
- Operations – terms of trade, pricing policy, proper registration of patents/trademarks.
- Improving current and forecast profitability – remove non-essential costs.
- Enhancing company appearance – present the business in its best light.
- A “Balance Sheet manicure” – e.g. pay down debt, harden attitude to working capital management.
- Building a solid management team – groom successor / second tier management.
What is your business worth?
Owners and advisors need to understand value in order to determine if financial objectives can be met. Value is largely determined by pre-tax ‘sustainable’ earnings, multiplied by a price earnings ratio/multiple, with an adjustment for excess assets.
Company multiples differ and largely depend on risk. Factors to be considered in assessing risk include:
- Dependency on business owner.
- Sustainability of competitive advantage.
- Growth and profit trends.
- Business disciplines and practices.
- Industry sector.
- Size of company.
- Environmental and economic factors.
Companies with a blue chip client base and reputable brand name will generally attract higher multiples. Intangible benefits, e.g. intellectual property attract a premium.
Taxes on exit
Entrepreneurs' Relief (“ER”) allows individuals to claim relief on qualifying gains made on the disposal of a trading business.
For those that qualify, up to £10m of lifetime capital gains (£20m in most husband and wife owned companies) will be taxed at 10%, as compared to 28% (for tax payers at the higher rates).
In order to qualify for ER, you must have held the business being sold for at least one year. If shares are being sold, the individual must:
- own at least 5% of the ordinary share capital and have at least 5% of the voting rights; and
- be an officer or employee of the company.
Common pitfalls include:
- significant non-trading activity, e.g. large cash balances;
- less than 5% ownership and voting rights (ownership and control can often be diluted by voting rights attached to preferential shares and the exercise of any employee share options); and
- share transfers to a spouse who is not an employee or director of the company.
ER relief is not always available, but advance planning may improve the position. How the sale is structured will also be key in deciding how much of your hard earned value is lost to the tax man.
How can we help?
If you delay in developing an exit plan, to include associated tax planning, you may not maximise value. Selling a business is not dissimilar to selling a product or service. In all cases, an active strategy is required.