How and to whom you should leave your business are difficult questions for any business owner to address.
You can pass it on in your Will or during your lifetime. It might be at a stage in its lifecycle where you hand over management with relative ease, or it may still require a lot of nurture, time and possibly industry knowledge.
The following article covers what you should consider when making your decision.
How much tax your estate will pay given the value of your business is less of an issue that you might think.
If you leave or pass a whole business to someone or a group of people, there is 100% relief on the inheritance tax that would otherwise be due.
If you leave over 50% of the voting shares of a company then there is a 50% relief on the value of those shares.
There is a 50% relief for qualifying assets - property or machinery - that were used in a business.
See Gov.UK for what qualifies for reliefs.
These Business Property Reliefs ('BPR') were introduced in 1976 when the government realised that it was more beneficial to keep businesses going after the death of an owner than to force their sale by requiring inheritance tax to be paid. A forced sale not only realises a lower valuation for the company, but also results in a loss of ongoing income tax from employees and a possible requirement to pay subsequent unemployment benefits.
You can pass on a business during your lifetime and still benefit from these reliefs.
What matters to most business owners is the continued growth of the business, and/or its ability to generate income for family members and/or making sure it continues to be run as intended.
Are you restricted by the business structure?
There are many ways that you might own your business. You may be a sole trader, or a partner in a partnership or you may conduct your business through a limited company. In the case of the latter, you may own a majority or minority shareholding.
You should consider both that your options might be limited by the current ownership structure; and that transferring ownership is likely to change the future structure.
Current ownership considerations
As a sole trader or sole owner of a company, you have complete freedom to pass on your business as you like. You aren't restricted by others in your choice of what to do.
If you are a partner or own less than 100% of the company, you may be circumscribed by the partnership agreement, or exit clauses in the shareholders’ agreement, or by the complications of being involved with others.
(Note that technically a partnership ends automatically if a partner dies. Only by having a partnership agreement that considers continuity can a partnership continue.)
Quite simply, if you own the business with someone else, you might need to consider their wishes as to whom they might co-own it with after your death.
Well drawn shareholders' and partnership agreements will have thorough and practical exit provisions. If they exist, check them carefully. If you are bound by an agreement you do not like, contact the other owners and see what changes can be made. Exit provisions usually favour those remaining over someone departing, even if the departure was unexpected and unintentional.
Future ownership considerations
As soon as you give shares in the business to more than one person, the balance of decision making power is likely to shift.
If you own shares in a company, you have shareholder rights based on your ownership percentage. You may also have additional rights agreed under a shareholders agreement.
If you give away shares, you might 'dilute' the rights of the beneficiaries, and they may not be able to operate the company in the way you would like. Or the rights that you enjoyed under the shareholders' agreement might only be available if you transfer your entire holding to one person.
Maybe one of your parents left the family business they started equally to you and to your brother or sister. You have a good relationship with your sibling and the business has prospered. You both have 50% of the shares. In law, you both have certain rights, although both of you can veto any decision.
You have three children. Your sibling has just one.
When you die, your shares could be divided three ways. Your brother or sister’s shares will all go to your niece or nephew. That child will then have far greater power than any one of your children.
If the business is not incorporated, then rights are likely to be given by a partnership agreement (if there is one). The issue here is that by adding more partners, some stronger personalities may get their way more often or on important matters.
We assume that your beneficiaries are your children and spouse, but in your case you may have to consider alternatively or in addition: a former spouse, brothers, sisters, parents, and other relatives.
Whoever the beneficiaries are, your choices will depend on how you perceive the personal circumstances of each of them. Equality for children is fine in principle, but what if, before you die, one of them suffers a severe injury, has a divorce, has four more children, emigrates or builds a large business of their own?
The question you need to address is who will continue to run and build the business?
There are some amazing examples of a husband or wife taking over a business on the death of the spouse or partner, but they are the exception, not the rule. You have to consider not whether your spouse is capable, but whether they are a good fit for the role that up to now you've been doing.
Personality, skill and experience tend not to pass down the generations. Only you can assess the suitability of your children to business management. Your assessment will dictate the decisions you make as to your will.
However, we absolutely advise that you should not leave a controlling interest equally between your children. Stalemate in decision making leads to disaster for the business. If you have an odd number of children, the voting powers are more evenly distributed - if three children own one third each, any one of them has the balance of power between the other two. But if you leave the business to an even number of children, make sure decisions can be made come what may.
What about value of your other assets?
The courses of action open to you will be expanded or reduced according to the flexibility you enjoy by owning other valuable assets.
If equality is a prime aim, giving the business exclusively to one beneficiary may create a problem in the future if the business is an outstanding failure or success. But if others have had cash or assets instead, they are less likely to complain.
What you cannot do
Most entrepreneurs want two things: to keep the family together and to expand the business and family wealth to benefit future generations.
It is important that you understand the limitations of planning anything for an unknowable future. None of us can manage our affairs from 'beyond the grave'.
It is also sad but true, that siblings often drift apart from each other after their parents have died. Distance, rivalries, financial circumstances, success or failure, all contribute to this process. Just because you want the business to continue doesn't ensure that it will.
Valuations of companies
If the business as an asset doesn't qualify for 100% BPR tax relief, then the best way to avoid paying too much inhertiance tax is simply to assess the value of the asset realistically. We remind you that there is no singly valid way to value a company. Valuation is highly subjective. If you think a valuer has overvalued it, obtain another valuation from someone else.
You can reduce the value on the open market by making the company undesirable to anyone who is not a family member. By using a shareholders' agreement you ensure that only certain people rights to control the company.
Solicitors know little about company valuations - particularly probate solicitors. Accountants tend to be better, but rarely adequate. Valuation is not something many practice accountants do regularly unless they specialise in it. If you sell any shares at all within a few years of your death, you are providing a start point valuation to HMRC. If no shares have ever changed hands it is far easier for your executors to choose a valuation method that minimises the value of the company.
Be careful with fee rates. Your executors should never, ever, agree to pay any fee except a fixed fee. Professionals are paid either by the hour or as a percentage of the valuation. A fee of £10,000 looks very reasonable for a valuation at £1 million, but rather high for a valuation of £100,000. But the difference to your estate is IHT on £900,000. If you want to win tough negotiations with HM Revenue and Customs, your executors must pay for that service as an extra.
(Another tip is never to ask for a 'probate valuation'. Those words make the valuer see pound signs before their eyes).
Options for your business
The following points are not related or given to you in any particular order. They are simply the fruit of many years as a commercial solicitor in private practice.
Sell the business now
Of course this is only practical if you are of an age when you want to lose your interest and motivation to expand it. You pay capital gains tax at a concessionary low level but your net cash, or assets you buy with it, are readily identifiable and will no doubt be subject to inheritance tax at the top rate when you die.
Give some shares to your beneficiaries now or gradually over a period
To qualify as a gift for IHT purposes, the gift must be complete. So, avoid letters telling the donees that you are still in charge.
Remember that Business Property Relief exists and also that gifts made at least 7 years before your death also are exempt from tax.
From a capital gains tax perspective, your beneficiary will be taxed if they ever sell the business on the gain from when you acquired it (and not them). In other words, they also 'inherit' the starting valuation that you had.
Give a few shares to each beneficiary now
Have them sign to a carefully drawn shareholders agreement which cannot be changed without say, 80% of the shareholders agreeing. If you retain 90% of the shares, nothing changes while you live and you keep control.
When you die you leave your shares equally among your spouse and three children. There will not be an argument about power and control because you have already covered all that in the shareholders agreement they have already signed. They can change it only if 80% agree.
Write a comprehensive letter of intent to place with your will
A letter of intent does not carry any legal weight, but it is rare for executors to fail to do as you ask. Conversely it would be difficult for a beneficiary to claim they were unfairly prejudiced in some way. Such a letter is rarely used as fully as it could be. Solicitors do not like non-legal documents. But just a few examples of things relating to your business on which you could advise your executors are:
- appointment of directors
- appointment of independent chairman
- rate of expansion
- customer relations
- export markets
- information to be given regularly to all shareholders
- access to critical passwords
- control of bank accounts
Appointment of an interim chairman or director
An independent outsider as director or chief executive or as chairman of the board can be a brilliant move or a complete disaster.
If you have a trusted insider, it could be a good move to make clear to your executors that they are to replace you as chairman - maybe for a maximum term so as to enable one of your children to grow into the job.
We advise against appointment of a professional solicitor or an accountant unless you have specific problems they can address.
An external entrepreneur is likely to end up making a bid for the company.
Placing the company in a discretionary trust
We turn finally to the most intriguing proposition of all: using a discretionary trust.
Most income in a discretionary trust is taxed at 45% (2022/23). Dividend income is charged at 38.1%. So you should avoid transferring into trust assets that yield high income.
There can also be entry charges when assets are placed in trust, a '10 year charge' every 10 years and exit charges.
So the reasons to use a trust may not be financial, but rather control and business continuity.
The advantage of a discretionary trust is flexibility. The management of the trust is in the hands of trustees, but the company is run on a day to day basis by the directors.
The trustees are in a very powerful position but a letter of intent (or even trust rules) can set out the principles on which you want them to exercise their control. You may or may not want one or more of the trustees to run the company, but we are talking here about their role as trustees of your family trust.
Examples of the areas of influence are:
- appointment and dismissal of directors
- directors’ pay and service contracts
- influencing the directors on behalf of shareholders who are not directors
- transferring shares to beneficiaries
- approving the direction and master policy of the company
Several Net Lawman wills include a discretionary trust. Of course, there is no reason why you should not set up a discretionary trust now. It does not have to be a will trust.
We recommend that you read about making sure an inheritance stays in the family next.
We believe that every adult should make a will. We provide some of our more straightforward templates (likely to be suitable for most people) absolutely free with no catches or conditions.
Just visit our library and choose the most suitable from the list of will templates. We offer nine in total that together cover thousands of possible variations of wishes. There will be one to suit your situation. If you are in doubt as to which to choose, read about which type of will suits you best.