With uncertainty everywhere, Chloe Rigby asks how business owners can make sure their wealth is secure for the long term.
Financial advisers are used to cautious investors asking whether their stock-market investments are safe.
But until recently they had never seriously had to ponder the question of whether cash was safe in high street UK banks.
Not surprisingly, just now that’s one of the most frequent questions they get, following a stream of previously unthinkable events, from the collapse of US investment bank Lehman Brothers to the nationalisation of the UK’s Northern Rock and Bradford & Bingley – and the staggering partial nationalisation of RBS, HBOS and Lloyds TSB.
“Nobody felt the need to ask until this time last year, says Derrick Royall, associate partner at Crystal Wealth Management. “The difference in this downturn is not that people are worried about losing their shirt on the stockmarket, but that people are worried about losing their money full-stop.”
Business owners could be forgiven for thinking the banking crisis has changed the way they plan for their future. But it hasn’t – the basic principles remain the same, according to Gavin Jones, of Old Mill Accountants and Financial Advisers in Shepton Mallet.
“The difference you can make to business owners and those with money in terms of income tax, capital gains tax and inheritance tax is very important,” says Jones, a chartered financial planner at the Shepton Mallet firm.
So if it’s back to basics when it comes to building and securing wealth for the long term, what are the basics that business owners should consider?
Just as recent events in the financial markets were unforeseen, business owners can never know exactly what the future will bring. They may have built up a profitable company, but few plan for the worst. Illness that stops a business owner from working or, in the worst-case scenario, death, are both issues that nobody wants to dwell on, says Jones. Having insurance protection, he says, is the first thing to think about.
“A lot of business owners have substantial worth tied up in their company,” he points out. “And if a business owner were to die or be unable to work for a long period of time, it would make a substantial difference to many small companies. Not only are they faced with a loss of perhaps a top salesman or the person dealing with issues in the company, but they still have to live, pay their mortgage and feed their family.”
To that end, he says, business owners should make sure they are protected by a company or personal insurance policy that would pay out a lump sum or income in case of disaster, and might also provide an injection of funds to keep the business going while a replacement manager is found.
The stereotype of the successful business owner is the drive he or she has to make as much money as possible to buy the large house, the car and the lifestyle.
But Derrick Royall of Crystal Wealth Management says more and more entrepreneurs are developing new approaches that balance financial needs with the needs they have in other parts of their lives. He says: “Society in the Western world has got wrapped up in material things.
“But the wider picture is simpler: are you happy yourself, are you healthy and are you looking after your fellow human beings?” That means making a plan to achieve what you want from a business, rather than just chasing cash, he says.
One of the decisions to be made in early business planning is whether to set up as a sole trader, partnership or as a limited company. Mark Lee, chairman of the Tax Advice Network, points out the tax advantages of operating as a sole trader or partnership – businesses that make a loss in early years may be able to set that off against income earned in previous years, whereas limited companies can only set off losses against future years. At a later date, the decision can always be made to incorporate as a company.
For those who opt to set up as companies, it may be more tax-efficient to take dividends from the company rather than a salary or a bonus, since dividends are taxed at a lower rate. But, says Mike Warburton, Bristol-based senior tax partner at Grant Thornton, the decision will depend on individual circumstances and what rate of corporation tax is paid by a company, since salaries and bonuses are paid before corporation tax is assessed, while dividends are paid afterwards.
But, advises Warburton, business owners should not be overly concerned about tax in the early years of a business. “I have seen too many people get hung up about tax and not think about the most important thing which is having a profitable business,” he says.
Paying into a pension plan is “nearly always the best” way to take money out of a business, says Warburton.
“The company gets tax relief on the pension contribution, there is no national insurance, and the individual doesn’t pay tax till he or she receives their pension – and then they can take a 25 per cent tax-free lump sum.”
But at a time when the markets are troubled, is there a flight to safety out of stocks and shares-based pensions?
The surprising answer is not really, according to the financial advisers Insider spoke to. Des Ryan, business development manager at Allied Irish Bank, says: “Equities have taken a bashing, and pension values are affected by that. But equities are not a short-term play, they’re a medium to long-term investment. People on a regular scheme, investing all the time, can benefit from purchasing at times like this when values are on the slide and cut the risk by regular investing.”
However, pensions don’t have to be invested in the stockmarket. Lee says that money from some pension plans, such as SIPPs (Self Invested Personal Pension), can be used to finance the acquisition of the business’ premises. “That can be done in a tax-efficient way if certain conditions are satisfied,” he says.
The downturn in the market can be a business opportunity for enterprises looking to increase their market share – as long as they can access the cash available to expand.
Ryan, however, warns that traditional debt is likely to be remain expensive – and business owners should plan for that. “The cost of borrowing between banks has gone up and it is going to remain more expensive for clients and companies to borrow funds from the bank,” he says.
Jones agrees, suggesting that businesses might want to consider other sources of funding. “The venture capital side of things is very attractive at the moment,” he says. “There is substantial private capital out there and for some people the tax relief that that can achieve is very attractive.”
It can take a lifetime to build up a business – and with it, wealth. While that wealth is tied up in an unquoted business it is usually exempt from inheritance tax, under the business property relief scheme. But many business owners realise their wealth when they retire by selling up – and at the moment that their worth becomes tangible cash, both inheritance tax and capital gains tax start to become a real issue. “Once you sell a company you have to completely rethink your tax planning,” says Warburton.
Planning well ahead of selling a company is important, says Lee. “History is littered with people who have paid more tax than they needed to when they sold all or part of their business,” he says. “If they thought about it they could have reviewed shareholdings, and thought about capital gains tax. That’s now payable at a flat rate of 18 per cent after the first, exempt, £9,600 of gains, compared with higher rate income tax at 40 per cent. It makes sense if you are coming up to selling the business to reduce your renumeration, on which you might have to pay tax of up to 40 per cent, and pay 18 per cent CGT instead.”
It is clear that business owners should be planning for future success. One day, the odds are, this recession will just be part of history. Those who plan ahead now will, by then, be enjoying a time of growth, happy in the knowledge their wealth is secure.