Managing Your Wealth
Considerations for Business Owners
For the majority of individuals, their primary sources of wealth is their main dwelling house and pension. In some cases, in what is a uniquely Irish experience, it may also include one or two rental properties. For a business owner, however, a different dynamic operates based on the value enshrined or accumulated within the business itself and the decisions required in applying that value for the benefit of them and their family. The possibilities and the considerations involved will depend on the business’ life-cycle and the life-cycle of the family or those family members involved in the business.
Usually, for a first generation entrepreneurial business, the founder makes many sacrifices in establishing the business, often in many instances not taking a full salary or profit extraction for many years. Where the business is successful, there is however greater potential to accumulate wealth due to trading profits being liable to corporation tax at 12.5% as opposed to marginal rates of personal taxation (i.e. at up to 55%). However, the wealth represented by the business results in a number of important considerations, including:
- Where the business is at an early stage, the value represented in it may very well be dependent on the business owner/founder and their early demise could have a detrimental impact on both the business and its value for their family. Thus, various contingencies around death and disability should be considered with appropriate insurance cover to protect the family in case of such unfortunate circumstances.
- Often, due to sacrifices made early on in establishing the business, a business owner’s pension provision may be wholly inadequate and, as such, in later years a greater part of the profits may be required to be contributed to a pension scheme to provide an adequate income in retirement.
- The other primary question most business owners will face at some point is the outright acquisition of premises from which they can operate the business and whether the premises should be acquired personally with a lease to the business, or acquired by the business itself. Differing tax considerations will arise from both a financing perspective and a debt repayment perspective, and also based on: whether the premises could have an alternative use outside of the business; and whether retention of the premises in a personal capacity provides the capacity for an income in retirement (where leased to the business or to other individuals should the business cease trading).
- Finally, the risks inherent in any debt arrangements made by the business can have a significant impact on the business owner and the level of leverage in the business. In particular, personal guarantees for corporate debt carry significant risks that have potential to eliminate the value represented by the business and the value held personally that has been extracted from it.
Assuming all of the above matters are in hand and the business is generating cash surpluses, other considerations will come into play, including:
- Outside of any risk from debt arrangements, surplus value within the business is still potentially subject to trading risk. Accordingly, the question arises as to whether to have more than one company so that the trading risk can be located in one entity, with surplus value being held in a second company.
- Where surplus value accrues within the business, the business owner must weigh up the possibility of extracting that value personally or retaining that value within the business. Where that value is retained within the family company, it raises the question as to whether surpluses should be reinvested in the business itself or invested elsewhere for a (potentially) greater return. If the business is undergoing a growth phase, it is usual to reinvest business profits in upgrading systems, acquiring new plant or business premises and expanding into new markets. The founder is often making personal sacrifices in foregoing immediate personal return to ensure the business’s viability in anticipation of future returns. Where the business is well established, applying surplus cash involves a decision: would a higher return be available if surplus cash is invested in the existing business or would it be available by investing it elsewhere? Against further investment in the business, there is the commercial requirement for diversification, be that diversification by investing in other assets within the corporate structure (as already mentioned, within a second company) or extracting value from the business so that assets and wealth are held outside of it and not subject to trade risks.
- In addition, if there are other family shareholders that may create an alternative dynamic. Extracting too little value may leave certain family members disgruntled, giving rise to potential for personal conflicts that could negatively affect the business, while extracting too much value to satisfy demands of family members may result in the business suffering. The future strength of the family business depends on balancing the level of financial reinvestment required against holding wealth outside the business so that the family is less reliant on it and thus has some protection in the event of any deterioration in its performance or value.
- Where assets are retained within the company, passive non-trading income is taxed at 25% and may also be subject to the close company surcharge. Thus, investment income may carry an effective tax rate of 40%. Any gains would be liable to capital gains tax in the normal course and you still have a second tax charge should you ever wish to extract value from the company. In contrast, extracting value to invest in a personal capacity results in less capital for investment purposes due to marginal rates of income tax. Thus, owners need to consider the overall balance in deciding whether surplus value should be applied inside or outside the company. Where investments are leveraged, the company would generally constitute a better investment vehicle.
Finally, the business owner should also consider the application of the value of the business on their ultimate retirement or exit from it. This usually will involve the decision as to whether it is best to sell the business or transfer it to family members. Where surplus value has accumulated within a company due to reinvestment in non-trade assets, it may be appropriate to segregate the non-trade assets/investments into one company and have the trade sit in another company, and this may be achieved on a tax-neutral basis. Thus, it might facilitate a sale of the trading business with a retention of the investment business for the family, or it might even facilitate succession to the trading business by certain family members, but with the investment business being held separately to provide either for the founder in retirement or a transition to other family members.
Family dynamics and considerations of other family issues may place additional requirements on the business owner, and this additional emotional component can temper what might otherwise be a pure investment or business decision. Often business owners may not structure their affairs appropriately as they are too busy in the day-to-day operation of those businesses, or they shy away from complexities in ensuring they are structured properly. The biggest single differentiator is looking at the risks to the value that has accumulated within the business and attempting to eliminate or minimise those risks. Frequent review of these issues by the business owner should be part of a comprehensive holistic approach to management of wealth represented by the business.