Debunking the myths around succession planning for entrepreneurs

Business people make for incredibly interesting clients. It stands to reason that they are sharp, driven, and commercially focused. It takes both brilliance and resilience to build your own working legacy. Yet the investment required to do so can often make it hard to contemplate letting go, or passing on the mantle.

But what are the pitfalls of failing to undertake succession planning in good time? Here we examine a few common assumptions relied upon by entrepreneurs, and discuss the dangers of giving such assumptions credit.

1. "I'm not planning on either death or incapacity any time soon. Until then, I need to be in control."

Dying is unfortunately a certainty.

Events may also happen before that time which means it becomes impossible for your business to continue.

The statistics on cognitive impairment can be staggering, with dementia now being the seventh most common cause of death, worldwide.

The effect of incapacity for business owners can be severe, where steps have not been taken to ensure you grant legal authority to an attorney to deal with your business interests. This sort of planning is crucial. It has absolutely no impact on your ability of continuing to manage your business independently whilst you remain mentally capable. Rather, it is insurance that every individual with valuable commercial interests should implement. Simply put, you don't put your seatbelt on because you envisage crashing your car. But statistically speaking, it almost always helps if you do.

In a similar vein, planning to address what will happen in the future does not necessarily mean taking any imminent radical action to restructure your business.

However, it may well just illuminate risks of 'doing nothing' of which you were previously unaware.

The process can sometimes involve simply constructing a timeline as to when certain planning should take place, dictated by your objectives, but with an eye to tax planning most effectively. By contrast, doing nothing comes with definite risks.

What would happen to your business if you become too sick to continue working? Would the enterprise be sold, or would your wish be that your fellow shareholders/partners be able to continue the trade, and acquire your stake it in the business? Is the value to pass to your family members, and how do you ensure that they get a fair price for this, and their rights are protected?

Addressing the above involves consideration of:

1. The 'constitutional' rules of the business, whether written or implied;
2. The benefit of investing in keyman insurance for each business owner and creating trusts for the mutual benefit of one another; and
3. Your will.

Your will must dovetail with the other corporate documentation and agreements, so joined up thinking is required.

2. "I know my business won't be subject to Inheritance Tax on my death, so I don't need to worry about how that cost will be covered."

It's true that shares, partnership interests or the business of a sole trader can qualify from relief from inheritance tax (IHT) under certain conditions.

This is known as Business Property Relief (BPR). The qualification criteria for BPR are however important to consider before the day comes when eligibility for the relief will be tested.

Your business must be mainly 'trading' in nature (rather than investment), to qualify. If you operate a genuinely 'mixed' business, it is important to consider how precisely this is structured and operates (trading vs investment). The resources employed to each activity, as well as turnover and other factors, should be carefully analysed.

The value of any assets held on the business's balance sheet which are not fundamental to its trade will be excluded from the relief.

Equally, directors' loans are not business capital, but debts payable by it. The value outstanding will be owed to your estate on your death, and will therefore be subject to IHT.

There are however often restructuring opportunities which, when addressed early enough, can solve 'problems' in these areas and save significant tax.

3. "Will my spouse automatically inherit my business interests upon my death, anyway? If this is what I want, what's the need for planning?"

If you die without a will, then the intestacy rules do not always apply to exclusively benefit your spouse. This is a common misconception. Children will take a benefit when your estate exceeds a certain value, and the distribution can be very complicated. It also very rarely reflects what an individual would like and causes practical problems, particularly where minor children are in issue.

We also need to re-consider some for the factors noted above here. The constitutional rules of your business will affect exactly how your interest can be dealt with, in practical terms, on your demise. This is the case even if those rules are purely implied by law, as in an unwritten partnership. The terms of your will therefore need to be considered in conjunction with these rules. If the rules aren't ideal, then the opportunity to revise them in accordance with your objectives must be taken.

From a pure IHT perspective, it is also generally inadvisable to leave assets that will qualify from BPR directly to a spouse.

This is because the spouse exemption from IHT will apply to the full value of assets transferred to a surviving spouse, regardless of the nature of those assist. If eligibility for BPR on the business assets is however lost following the first demise, then that value will face IHT on the second death.

Alternatively, you can ring fence the BPR-qualifying assets by passing these to a trust on your death (from which your spouse can still benefit). This aims to capture the relief when you have certainty it is available. You therefore avoid inflating the second estate with value which could become chargeable to IHT in future.

There is also then opportunity (in circumstances where the business does continue trading and the spouse does not need all the deceased's liquid capital) to try and secure BPR a second time, on the survivor's death. This involves careful structuring, but can be outlined in the course of discussions around your will and succession planning generally.

Conclusions

If you're a business owner, you cannot leave the matter of succession to such an important legacy to chance.

You should start planning at an early stage. Against the backdrop of your overarching objectives, you should ensure this process involves consideration of the nature of your business and its structure, potential risk areas, and the constitutional rules of the enterprise, alongside your will and power of attorney documentation.

If you have any questions on this, or any other estate planning matters, please get in touch.