10 min read
The Tax On Selling A Business And Its Effect On The Business Sale
At the start of this series, we defined a ‘perfect’ sale as a fast, optimised sale, with the right buyers or investors, with the right terms and timing, minimal tax on selling a business, and a rewarding onward journey. This article considers what we mean by a rewarding onward journey by looking at earn-outs, wealth, tax and the next steps.
A ‘perfect’ sale for some business owners would be an outright exit – to take the money and simply sit on a beach away from it all. However, it should be noted that many sellers are favouring partial sales to private equity investors whereby they retain a stake in the business post-sale. This enables them to participate in the future growth of the company they founded, whilst diminishing their involvement over time.
The retained stake can often provide an exceptional investment with the ability to triple its value. Some sellers are also opting to sell to their employees via an Employee Ownership Trust. These vendor-led transactions again facilitate a slow handover and, best of all, they are currently 100% free of Capital Gains Tax (CGT).
Tax On Selling A Business
We need to understand how the proceeds on the sale of your company shares will be taxed. In recent years, the tax regime has been very benign on the capital gains on such sales with 10% levied on the first £10 million per executive shareholder. In March 2020, this changed to 20% on the total sale, although the first £1 million remains at 10% assuming you qualify for Entrepreneurs Relief (Now Business Asset Disposal Relief).
With the requirement to raise revenue, CGT has been reviewed by the Office of Tax Simplification. Their report, which can be found on their website, suggests that CGT will be aligned with Income Tax at 40% with Entrepreneur’s Relief being replaced with a less generous retirement relief but what that percentage might be we do not as of yet know.
The tax on selling a business can and should be seriously thought over, whether or not you would prefer the 0% CGT and all of the benefits of an EOT is a serious question to ask yourself. However, if they do change the tax regime, now is the time to accelerate your ‘perfect’ sale’ and start your rewarding onward journey. A big hike in taxes will fundamentally change the way people think about business sales for good. In recent times, the success of the entrepreneur has been the ability to build a business to create maximum shareholder value and then cash-in, as more wealth can be achieved in this way than out of future income.
A change in taxes may discourage reinvestment for shareholder value, restrict growth, and make selling companies far less attractive. More likely it will simply drive executive shareholders offshore. Portugal, Italy, Guernsey and the Virgin Islands all have very favourable capital gains regimes – you need to live there for 5 years but can visit the UK for 90 days which under the 24-hour rule is almost 180 days.
However, the tax on selling a business is what it is, and unless you go down the EOT route, it will always be there. Tax is tax, and the rate will be what it will be. At some point, you will choose to sell your business and if you have no direct succession and you will want to engage in new opportunities, be it trying something new or, in many cases, after the exhausting pressures of building a successful business, to enjoy the ‘rewards’ of a perfect sale.
To understand this better we must define the rewards of a perfect sale as more than money for you to achieve your individual rewarding onward journey. ‘Wealth’ encompasses purpose, health and relationships. The world’s richest man in the early 1970’s was John Paul Getty – with 6 failed marriages he confessed “I hate to be a failure. I hate and regret the failure of my marriages. I would gladly give all my millions for just one lasting marital success.”
Money without happiness has no purpose, so does the tax on selling a business matter as much as the purpose and means behind the sale? The Dalai Lama adds that some of the richest people he knows are from the West as their sole focus is to accumulate material things, and the more material things you have, the more hassle you have from security to maintenance. Elon Musk, currently the world’s second-richest man, has started selling off his possessions. When he announced this, he said “I don’t need the cash. Devoting myself to Mars and Earth. Possessions just weigh you down.” Mars and Earth, now that’s a purposeful journey and vision – whatever your views of this gamechanger!
If, however, we must talk about money as part of the perfect sale, perhaps we could start with what a millionaire is. A millionaire in history is a synonym for being able to fund a luxury lifestyle. That is, owning a detached house with an in and out driveway and electric gates, and, perhaps, a holiday home. A few great cars, luxury holidays and the ability to dine out, all without working but living on investments. By my calculations, outside of London (and perhaps the home counties), this is probably achievable today with £4 million, net of tax and costs.
If your goal is to be a millionaire then you need to have built up £2 million in wealth pre-sale and then sell out for £2 million net. I have assumed you can invest half and achieve a 5% yield on these investments, giving an income of £100,000. I have also assumed low costs, although the cars can be on lease.
But is building your company to be a ‘millionaire’ really what selling is all about? Having looked at Elon Musk and John Paul Getty, I would suggest not. This is because many owners struggle to find purpose after a sale – it is almost like a form of grief as so many of their relationships have been centred around business and its time demands and suddenly they lose their sense of ‘doing’.
After selling, they touch what feels to them like the void of simplicity, that is, simply ‘being’, and they panic as they are unable to switch their self-esteem from ‘doing’ to ‘being’.
If you are to make X amount of money out of a business sale, you must ask yourself; regarding tax on selling a business, will the extra capital you could earn through lesser taxation actually lead to a greater return? Would it make a whole load of difference if you were unsure how to handle the pay out regardless? Add to that say, if their ambition was only ever monetary, they never feel rich because almost no matter how financially rich they are, somebody is even richer. Elon Musk this year has been earning the equivalent of £12 million an hour.
One of our team’s favourite books is ‘Three Men in a Boat’ by Jerome K Jerome. It is funny and very wise. There is one extract, in particular, which is striking and provides a great guide to ‘wealth’ which we need to appreciate to understand the perfect sale:
“How they pile the poor little craft mast-high with fine clothes and big houses; with useless servants, and a host of swell friends that do not care twopence for them, and that they do not care three ha’pence for; with expensive entertainments that nobody enjoys, with formalities and fashions, with pretence and ostentation, and with – oh, heaviest, maddest lumber of all! – the dread of what will my neighbour think, with luxuries that only cloy, with pleasures that bore, with empty show that, like the criminal’s iron crown of yore, makes to bleed and swoon the aching head that wears it!”
“It is lumber, man – all lumber! Throw it overboard. It makes the boat so heavy to pull, you nearly faint at the oars. It makes it so cumbersome and dangerous to manage, you never know a moment’s freedom from anxiety and care, never gain a moment’s rest for dreamy laziness – no time to watch the windy shadows skimming lightly o’er the shallows, or the glittering sunbeams flitting in and out among the ripples, or the great trees by the margin looking down at their own image, or the woods all green and golden, or the lilies white and yellow, or the sombre-waving rushes, or the sedges, or the orchids, or the blue forget-me-nots.”
With all of this being said, the tax on selling a business is just as important and isn’t to be scoffed; financial freedom and the end pay-out will be decided by this. So yes, a ‘perfect’ sale is probably one that creates financial freedom, ideally that of a millionaire, but understanding why this creates ‘wealth’ for you is different for everyone. I choose to define it as one that fits a purposeful life – but it is your journey, so you must define your ‘purpose’ and this in turn will define your ‘perfect’ sale.
If you would like to discuss any aspect of our services in confidence or would like some advice, please call +44(0)20 7788 8250 or email firstname.lastname@example.org.