7 Risks to You as a Business Owner

Date : 10 Apr 2019
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posted By : eff_admin

Did you know that 80% of businesses fail in their first 5 years? ‘Even if you have made it to 5 years, 80% of those businesses fail before they make it to 10 years’. (Jurie Van Dyk, ‘Why 9 out of 10 Businesses Fail’, http://creativeoverflow.net/why-9-out-of-10-small-businesses-fail/) But why is this? Surely the economic crisis that began in 2007 cannot be accountable for every single business failure? The answer is no, it cannot. Instead, the demise of such a large percentage of businesses is down to 7 risks that business owners are exposed to.

This paper aims to take an in-depth look at all 7 of the risks that business owners will encounter on their corporate journey. The paper will explain what each risk is and how you can overcome the hurdles that could cost you your business. Furthermore, this document will look at strategies that will not only safeguard your business but could double your wealth.

To give you some contextual information about the authors, we are a financial planning firm called ‘Efficient Portfolio’. Our team is made up of a group of highly qualified and experienced individuals, who are able to give advice on a range of financial areas- whether you are a company or an individual. Our team have over 60 years combined experience and operate in London and Rutland. We take a holistic approach to financial planning; rather than look at specific products, we take each client through a life planning process, which aims to indentify each individual’s personal hopes and dreams. We then concentrate on building an approach to your financial planning that is as unique as you are.

In our experience, many business owners share similar concerns regarding their finances. Many are worried that they are not maximising the return on their efforts and are unsure about when to leave the business. Others are anxious that they pay too much tax. And some are struggling to understand how to ensure that their family and business are secure for the future. Helping these individuals has put us in a great place to help others in the same situation. It is our hope that this paper will be able to help you.

Chapter 1- Start With the End in Mind

To start at the beginning, we need to begin at the end. It was once said that ‘if you don’t have an exit strategy, you don’t have a business- just a highly paid job’ (Stever Robbins, ‘It Takes a Lot More Than Attitude to Lead a Stellar Organization’, http://www.entrepreneur.com/article/78512). But what does this all mean? Well, let us begin by looking at the first risk to your business- the ‘Exit Strategy’.

‘Just as you needed a plan to get into business, you'll need a plan to get out of it. Selling or otherwise disposing of a business requires some forethought, strategizing and careful implementation. In some ways, it's a little more complicated than starting a business. For instance, while there's really only one way to start a company, there are at least three primary methods for entrepreneurs to leave the businesses they founded: selling, merging and closing’. (http://www.entrepreneur.com/encyclopedia/term/82404.html) This definition from the ‘Entrepreneur Encyclopaedia’, we feel, really encapsulates the meaning and purpose of an ‘Exit Strategy’.

The first idea that must become cemented in your mind is that in business nothing lasts forever. Just like a person, a business ages and goes through certain stages of ‘life’. It is vital to recognise at which point you, and your business, are at your strongest and most profitable. After all, understanding when your business has reached its maximum value is one of the ways that you could potentially double your wealth. An ‘Exit Strategy’ will enable you to plan for this point in time and know when you need to ‘get out’.

Before we go any further, we think that it would be beneficial for you to see a structure that we use in our Life Planning Process. The diagram which follows illustrates each stage of a business’s ‘life’ and details the characteristics of each level; it will help you to understand what you need to do to improve your business now. It will also help you to recognise what you need to do to in order to achieve the greatest value from your business.

1. Birth

This is the Moment you take on the risk of owning a business. You work to meet your own needs and are managing the company yourself.

2. Infancy

This level is a race for survival. You may hire a person, or persons, but you are still running the business. Your main focus is on production and cashflow is a challenge.

3. Toddler

Your business walks and talks on its own by now. You have also begun to build a management team. However, the business still relies on you for all core decisions. Everything is becoming accelerated, but cash flow still a concern.

4. Teenager

By the time you have reached the ‘teenage’ level of your business, you have begun to develop a professional team to manage your business. Cash flow is no longer a challenge and growth is your main focus. At this stage innovation is rampant and more means better. The leaders of your company no longer attend meetings and you become over confident. Trouble is imminent!

5. Young Adult

By the time your company reaches the ‘young adult’ stage, you are beginning to anticipate the future. You are making more committed choices and limiting what you focus on. You begin to focus on systems and redefine what success is long term. You have a rebirth of identity are starting to settle down and get serious.

6. Zone of Maximisation (Maturity)

This is the zone that we will be discussing in more detail later in the document- the time when you reach your optimum value. By ‘maturity’, you are reaping the rewards of your hard work. You will have developed a system for managing the business that allows you to consistently meet the needs of the community you serve and yourself in a sustainable way. The business is run by a management team and the organisation knows who they are, who they are not and what they will do in the future. Your sales and profits are growing.

7. Mid Life Evaluation

As you and the company age, things begin to break down. Entropy has begun and you evaluate whether to rejuvenate or to continue to age. At this level, you have to innovate or you begin to die.

8. Aging

The breakdown that began in the previous stage begins to accelerate. You are stuck in a state of denial and believe that problems are not that big. You are focusing on how you are the victim and you begin to blame and attack. Talented people start to leave.

9. Institutionalisation

Your organisation is kept alive artificially through subsidisation and only kept alive by systems rules and police. There is no innovation of focus on serving the needs of the community.

10. Death

Your vision is no longer sustainable and no- one supports it. Understanding when this phase could occur in your business will give you a much clearer idea of where to take your business next.

The diagram uses the metaphor of a human life and this is incredibly relevant. The business, after all, is yours so needs to reflect your own desires. The first point of consideration for your ‘Exit Strategy’ is to think about your own life plan. Where do you see yourself in 20 years? When do you want to retire? What do you want to achieve? And, ultimately, how much money will you need to provide these things? Once you have answered these crucial questions, you can start to make choices about the direction of your business.

In the former diagram, the optimum point for your business is depicted by a strong arm and relates to when your business is at its most healthy- it is making a profit, it is well organised and respected and growth is a key feature of the organisation. At this point, when the company will run without you, you stand to make the most financial gain from your company, and not just in terms of sales revenue. Whilst your company is successful it is attractive to buyers. In order to get the most out of your business, this is the point where you should sell or merge. Of course, all of this is dependent on your initial life plan. For example, you may want to retire at the age of 55 but analysis of your business shows that you will not reach your ‘Zone of Optimisation’ until you are 60. You then need to make the decision as to whether or not you work for 5 more years or you retire with a lower income. You may also be planning to hand the company down to your children. In this instance, you may want to hand the business over prior to ‘maturity’, in order for your children to make the greatest financial gain. Whatever you decide upon, you must have this clearly planned out in your mind- and on paper. Plans may not always run as smoothly as you want them to, but at least you have a clear vision and completely understand what steps you need to take in order to achieve your goals and ultimate outcomes. Once you reach ‘maturity’, it is perfectly possible to stay there and not move onto a ‘mid life crisis’. This can be done by constant and strategic innovation and improvement,

‘It's not enough to build a business worth a fortune; you have to make sure you have an exit strategy, a way to get the money back out’. (Stever Robbins, ‘It Takes a Lot More Than Attitude to Lead a Stellar Organization’, http://www.entrepreneur.com/article/78512) In short, an ‘Exit Strategy’ allows you to map out the direction of your business and will enable you to make the most money out of it. It is a vital tool that is used to pin point how far away you are from your goals and what you need to do in order to reach your desired level. More than that, an ‘Exit Strategy’ will give you peace of mind, as you will have a clear understanding of when to sell or merge your business, or even when to close. If you stick to this strategy, it can help you to prevent a situation where you will lose money, the business or no longer be able to support your family.

So in summary, start at the end and understand your next move to get there. You run the risk of failure if you do not have an ‘Exit Strategy’ in place and could potentially lose everything that you have worked hard for. Knowing when to leave the business (whether you sell, merge, close or hand the business down to your children) will not only increase the chances of you being able to fulfil your dreams, but could also double your wealth.

Chapter 2- Know Your Numbers

‘I often get asked what is the most common mistake business owners make when they are growing their business?  While I could say it is not setting goals, planning their time, generating enough sales or having effective marketing, the true factor must be the lack of financial understanding.’ (Kevin Stansfield, Action Coach Business Coaching)

As a business owner it is paramount that you have a firm grasp of your numbers. Failure to do so is a massive risk to your business and your wealth. This chapter will look at the key components of your company’s cash that you need to get to grips with. We have split this chapter into two sections; the first half will deals with Balance Sheets and Profit and Loss Accounts- two documents that you need to become familiar with. The second half will concentrate on your ‘Financial Freedom Number’ and ‘Cash Flow Forecasting’.

  • Firstly, let us look at the Balance Sheet. The balance sheet is one of the most important statements for your business's accounts. It shows what assets and liabilities a company has and how the business is funded (by shareholders and by debt: the financial structure of the company).1This document gives you a ‘snapshot’ of the business at any point in time and can show you the financial position of your business.
  • Think of the balance sheet like this, ‘If you cannot read the scoreboard, you do not know the score. If you do not know the score, you do not know the winners from the losers’.

    As you can see, the Balance Sheet helps to show what your business owes out, for example overheads such as salaries, utility bills and rent. The document also shows you what money is owed to your company and how much revenue is being generated by shareholders investments.The information that can be derived from the Balance Sheet will prove to be vital in accessing the financial stability of your company. Understanding the security of your business is crucial to the development of your organisation, which in turn will lead to the financial success of you as an individual and as a business owner. Also, and quite evidently, businesses need to use assets in order to build wealth. ‘Assets are the things that a business owns or sums that are owed to the business at any one moment in time’. (www.businesscasestudies.co.uk)

    It is not our aim to go into vast amount of detail regarding balance sheets here, but ‘Money Terms’ gives a great over view (below). I would recommend that you speak to your accountant regularly to ensure that you fully understand your Balance Sheet. It is no use just looking at these documents at the end of year and ascertaining what profit you have made and what tax needs to be paid and them filing them. These documents need to be reviewed on a quarterly basis, so that you are fully aware of the direction that this business is heading in.

    ‘A balance sheet is usually presented in two sections that must reach the same total — this requirement that the two sections balance is the reason it is called a balance sheet.’
    The typical format of a balance sheet is:

    1. Assets (Things and Stuff)
    2. Total Assets
    3. Liabilities
    4. Total Liabilities
    5. Net assets (total assets less total liabilities)

    The typical format of a balance sheet is:

    1. Equity
    2. Other reserves (such as the revaluation reserve)
    3. Retained earnings
    4. Total shareholder's equity
    5. Minority interests (only in consolidated accounts)
    6. Total equity

    A more simplified version of this would be:

    Whilst we are looking at Balance Sheets, it is worth mentioning Statements of Cashflow. The purpose of these documents is to show how changes in the accounts and income sections of your Balance Sheet  affect cash and cash equivalents. The Statement of Cashflow also breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. The statement captures both the current operating results and the accompanying changes in the Balance Sheet. You will need to ask your accountant to provide you with one of these.

    As I am sure you can imagine, failure to understand, or even check, your Balance Sheet, could result in you having unexpected outgoings and less money being drawn in to your business than believed. This in turn will lead to over spending, debt, sudden and unexpected pay cuts and even closure of your business. None of us want any of these to happen in our businesses, so make sure you know your Balance Sheet!

    Balance Sheets are often associated with Profit and Loss Accounts. This is because each year companies have a legal obligation to produce a financial statement. This statement is comprised of your Balance Sheet and your Profit and Loss Account. As we have already looked at Balance Sheets, let us move on to your Profits and Loss Account.

    ‘QFinance’ defines a Profit and Loss Account as ‘the summary record of a company's sales revenues and expenses over a period, providing a calculation of profits or losses during that time. Companies typically issue P&L reports monthly. It is customary for the reports to include year-to-date figures, as well as corresponding year-earlier figures to allow for comparisons and analysis.’ (http://www.qfinance.com/dictionary/profit-and-loss-account) Whilst a Balance Sheet is effectively a ‘snapshot’ of a moment in time, a Profit and Loss Account can be likened to a ‘movie’, i.e. it covers the events that happened over a specific period of time.

    Profit and Loss Accounts really do what they say on the tin; however it is important to note that the profits, which are the first section of your account, are gross, not net. Your gross profit can be calculated by deducting your cost of sales from your turnover, or sales revenue as it is sometimes called. For example, I sell sweets- I have to buy the sweets in from a manufacturer, which cost me 1p per sweet and sell my sweets for 2p each. If I sell 100 sweets, my turnover would be £200, however I need to deduct the cost that I have spent (£100) from this. This leaves me with £100 gross profit. Once you have made these calculations, you have covered the first section of your Profit and Loss Account.

    The second section deals with expenditure.‘As well as the cost of sales, a business will incur overhead costs. These costs can not directly be related to each unit of output made or sold - hence the name overheads. Overheads are typically referred to as expenses in the P&L account. Typical expenses for a business include items such as heating and lighting costs, as well as insurance and advertising. General administrative costs of running a business appear as administrative expenses.’ (www.businesscasestudies.co.uk) Once you have this, you are nearly there. The final calculation that you need to make is to deduct the expenses from your gross profit- this will give you your net profit figure.

    Your accounts department, or accountant, should be well versed in producing your Balance Sheets and Profit and Losses Account, but you need to understand them so that you can see the trends appearing and make sure that you are heading in the right direction. You need to understand them for yourself and know how to make these vital calculations. Even if you do have an accountant or accounts department, checking the numbers for yourself is crucial- it is your business so you need to know how much money you are making and how much you are losing. You cannot plan for a successful and secure future without knowing your numbers. And by that we do not just mean looking at the profit. This is a fictional figure that, on its own, cannot help you to run your business on a day to day basis.

  • Moving away from physical financial documents, we will now look at financial theory, namely Cash Flow Forecasting and your Financial Security and Freedom Numbers. We will start with Cash Flow Forecasting.
  • Cash Flow Forecasting is a crucial element of the financial management of your business. Just like your life, it is important to plan ahead. Cash Flow Forecasting will enable you to ascertain what your future cash requirements may be, for example, are you planning to expand, take on more employees or change locations? Planning for future costs may also help to prevent a future crisis which could cause your business to close without making you any profit for yourself or your family.

    You may have heard the expression ‘cash is king’ in business; “Sales are vanity. Profit is sanity. Cash is king!”.(Keith Cunningham, ‘The Vault’) But why is this? The answer is quite simple- if your business runs out of funds, and is unable to obtain a loan or additional financial backing, it will fail. In this scenario, you could be left with nothing- a huge risk to your business. Cash Flow, especially in the early days of your organisation and if you are a small business, is your lifeline- make sure you understand it and know how to predict it. After all, Cash Flow could mean the difference between you doubling your wealth or you owing money to a company that is forced into liquidation.

    In order to survive you must predict your company’s future Cash Flow, but how can you do this when the majority of accountants will not provide this for you? There are some great systems out there designed for this sole purpose. For example ‘Opics’, which ‘provides advanced risk management and compliance tools to help the institution to enhance the transparency of its operation; while its cash forecasting functionality and customization features allow for business re-engineering and fine tuning, as needs evolve.’ (http://www.misys.com/products/opics-plus.aspx) This system allows you to measure your results, so that you can change your activities to reflect the goals that you desire.

    Cash Flow Forecasting will help to identify any potential shortfalls in cash balances in advance – think of the cash flow forecast as an "early warning system". Think of this prediction as an early remedy to a potentially fatal illness for your company. Forecasting will also help you to prepare budgets for your business, this is a great way of planning when you can grow the business, expand your workforce or even branch out into new business sectors. A Cash Flow Forecast is also a requirement of your bank if you have received a loan from them.

    Along with your forecast, you can also implement some guidelines in the workplace which will help with your Cash Flow. For example, making sure that your business has enough money to pay suppliers and employees- before purchasing new goods, understanding when you can take on more staff and making sure that the business has sufficient funds to do this. There is nothing more damaging to your business than if disgruntled customers, employees and suppliers speak detrimentally of your business! You should also ensure that there is a solid system in place to check and chase any unpaid monies that are owed to you - there is no point doing the work if you are not going to get paid for it! If you spot problems quickly, underwrite any contracts correctly and risk-assess your deals, cash flow issues should be at a minimal.
    The final section that we will look at in this chapter relates to your Financial Security and Financial Freedom Numbers. Although these two concepts are related in terms of their calculation and meaning, the products and effects of the two concepts are completely separate.

    We all need a degree of money in order to live the life that we do. At the end of the day, (unless you are 100% self sufficient and live on your own island and do not have to pay for any services) we all have bills to pay, mouths to feed and costs to meet. Your Financial Security number is the figure that represents the sum you need in order to finance all of these costs. In short, the number reflects how much you need to earn or save in order to pay for the essentials. This becomes particularly relevant when you begin to consider retirement and how much you need to earn as a business owner in order to support yourself and your family. Always bear this figure in mind- it is the minimum amount that you need to make. If you earn less than this number, your business could be at risk if you do not make any necessary changes.

    So now we move on to you Financial Freedom Number. I mentioned earlier that this and your Financial Security Number are closely connected. They certainly are linked, in the sense that they are unique to you and represent the sum that you need. However, your Financial Freedom Number is not about necessity, it focuses more on how much you need to realise your dreams. Many people focus on Financial Freedom as an exact figure, or a net worth, which they wish to achieve. In ‘The Millionaire Next Door’ (Thomas J. Stanley and William D. Danko. ‘The Millionaire Next Door’, 1996) the following is suggested as a formula for calculating your target net worth:

    It is important to consider that with a Financial Freedom Number, your income is almost irrelevant- it is your expenses that count. For example, if you earn £100,000 each year you have a high income. But, if you spend £90,000 per year that money would not last very long if you were to retire or need to take an extended period out of the business.

    So why exactly do you need to understand these numbers? Well, knowing your Financial Security and Financial Freedom Numbers will change your focus and drive in the business. Without them you are simply attempting to earn as much as possible, but without any real reason. Mitch Stephen, a Real Estate Investor from Texas gives a great explanation of this in his blog; 'Financial Freedom happens when your wants and your needs are exceeded by your passive income. Once I heard that definition, everything changed… everything became crystal clear to me. I had been chasing money without knowing exactly why or how much I needed. How much was enough? I had nothing to measure by. Until I heard that definition I had always assumed that people who were ‘financially free’ were rich. After hearing that definition my life changed completely because I finally understood that being financially free and being wealthy were two completely different things.’(Mitch Stephen, http://www.biggerpockets.com/forums/62/topics/62793-a-definition-of-financial-freedom-changed-my-life)

    To summarise this, a nominal figure that may sound like a huge sum may not be sufficient for your personal needs. Equally, it may be more than you will ever need. To ensure that you and your family will be supported by the income generated from your business you need to calculate your personal Freedom Security Number. Likewise, if you want to be able to fulfil all of your dreams, have a perfect retirement or be in a position to give your children the life that you idolise, knowing your Financial Freedom Number is a must. They are different numbers for all of us but are key motivators for business owners. Knowing your numbers gives you a clear goal.

    To conclude this chapter, it really is all about knowing your numbers. Become familiar with your balance sheet and ensure that cash-flow forecasting is at the top of your priority list. Understanding your profits and losses could save your business and will also indicate where you are spending too much or not investing enough. Finally, make sure you know what you are working towards- even once you reach financial freedom, it does not mean that you need to pack up your business, but it is nice to know that you have the option.

    Chapter 3- "If plan A fails, remember that you still have 25 letters left"

    In life, and in business, we are always thinking ahead and dreaming of what could be. Plans that we make are created to fulfil a desire or a purpose. Take owning your own business as a very relevant example here; ask yourself why did you set up your own company? The answer is probably one of or a combination of several reasons; including earning more money, creating independence and freedom, to feed a personal passion or to serve a cause that you strongly believe in. Whatever the unique reason was that drove you to set up your own business, the core motivation that pushed you forward was to fulfil a personal dream or goal.

    When you wrote your business plan, if indeed you did, you would have carefully considered each element of your organisation- how it would be implemented, how it would work and the purpose it would serve. However the reason that each aspect of your company has been structured in a certain way is in order for you to reach your personal goal. To put this in to context, say that you wanted to sail around the world in your own yacht. To achieve this goal you set up your own business and decided that you needed to make a large profit. In order to do this, you may only employ a small work force, in order to lower over head costs. You may also decide to conduct all marketing in-house, again to reduce your overall spend, or even opt to sell services that you charge to provide, but do not cost you. However you have decided to structure your business, the reason you have done it this way, is so that you can make the highest possible profit and eventually buy your yacht. That is your plan.

    This chapter will cover a topic that is completely centred on risk, or rather risk management. As I have already mentioned, you set up your business in order for it to eventually provide the future that you dream of. You have planned and calculated that your company will generate ample revenue for you, so that you can lead a comfortable life and enjoy the pastimes that you chose. But what if this plan fails? What happens then?

    In financial planning, a phrase that is commonly used is ‘failure to prepare means that you prepare to fail’. This adage could not be truer here. We all know that sometimes plans fall through and the path we have chosen does not lead to where we had hoped it would. Imagine what would happen if you had pinned all of your hopes, and finances, onto your business’ success and it failed? The third biggest risk to you business is not having a backup plan.

    No matter how prepared you are to run your own business, things can still go wrong. You need a backup plan in place for everything. There is always a chance that something could go amiss and you do not want your goals and dreams to suffer- or even worse, your family. Take the economic downturn as a prime example. Thousands of companies have gone into liquidation and many have lost everything. As a business owner there are certain external factors that can affect your business, but if you have a backup plan in place, these factors will not make such a significant impact. You need to take somewhere between 5-10% of your total turnover and move that into a separate business, known as ‘the Money Machine’. This needs to build up to work without your time or input, so that later in life this can generate your income.

    Within your own ‘Money Machine’ you need to make sure that your money is well diversified. This will reduce the risk to this money. Not only that, strategic planning could mean that your wealth is doubled.

    There is so much that financial planning can do for your business and a lot of it you can do yourself. Financial Planning will give you a great backup plan as you can be confident that you have money put to one side if your business was to ever run into trouble, you needed additional funding, or if you wanted to expand and develop you company. Benefits to your employees can also be covered with careful planning. At the end of the day, you want to make sure that you are extracting the profits generated from your hard work in the most tax efficient manner and that you and your family will be secure in the future. Efficient Portfolio
    works closely with business owners, who often share the same concerns;

  • That the pension legislation changes in 2012 will cause an increase in costs, both as a result of pension contributions and as a result of increased administration.
  • That the pensions they have set up in the past are offering poor returns, and won’t provide sufficient income in the future.
  • That if something serious was to happen to the business owner or a key person in the company that profits would be adversely affected, the value of the company would be reduced and income could be at risk.
  • That if they were to die, the shares of the company, plus their other assets, would not be dealt with in line with their wishes, or in the most tax efficient manner.
  • That they would like to start drawing an income and capital from their retirement funds in the coming years, and that they are not sure the best way in which to do this.
  • Reliable Financial Planning can help to overcome these concerns in many ways, for example;

  • Introducing a company pension scheme in line with the legislation that came in during 2012
  • Reducing the costs and increasing the tax efficiency of their existing financial arrangements.
  • Identifying the most valuable employee benefits available to the company to aid staff retention and recruitment.
  • Drawing their income from the company in a more tax efficient manner.
  • Maximising the funds you have already built up for your retirement planning.
  • Utilising the tax efficiency of pensions to hold commercial premises, or loan back money to the company.
  • Spreading your money over a range of investments, savings accounts and pension pots will significantly reduce the financial risk to your business. Having these features in place also means that if the worst was to happen to your business, you have literally saved for a rainy day.

    A lot of financial planning can be done by you. There are a lot of tools online that enable you to set up ISA’s, pensions and savings accounts. There is also a great deal of literature on the subject, which we would highly recommend that you read. Efficient Portfolio’s website has a section especially geared towards individuals planning their own finances. Here you will find information about setting up your ISA, retirement calculators and useful blogs on a range of subjects. Visit https://www.efficientportfolio.co.uk/on-line-portals/ for more information.
    Alternatively, you may choose to employ a professional Financial Advisor. Whoever you chose, we will always recommend that you opt for someone who is independent. In the financial services sector there are three main types of advisers;

    Tied advisers
    There are advisers that are tied to one company, and these are known as Tied advisers. These are sales people for that company, and an example of such an adviser is someone who works at a high street bank. They can only advise you on that company’s products.

    Multi-Tied advisers
    There are also advisers that are tied to limited ranges of products, and these are known as Multi-tied advisers. Some of these would give the impression that they can choose from the whole market, but in fact they can only ‘sell’ the products of the companies that they are tied to. In some instances this may only be one company in the area of financial planning you need help in. An example of a company like this would be St James’ Place.

    Independent Financial Advisers (IFAs)
    Finally, there are Independent Financial Advisers (IFAs), otherwise known as ‘whole of market’ advisers. These advisers offer advice on the whole market and therefore have the most options available when it comes to meeting your financial planning needs.  An example of an Independent Financial Advisory firm is Efficient Portfolio Wealth Management.

    How are each paid?
    Tied advisers and multi-tied advisers will generally work on a commission basis. This means you are still paying for the cost of their advice, but you are paying through that charges of a contract they recommend. Independent Financial Advisers offer the choice of fees or commission to their clients. Fee based advisers tend to be able to give advice on areas not paying commission and therefore often forgotten. This includes giving advice on savings products, Trusts and Wills. They can still use the commission to offset the client’s fee, if that is what the client wants, but there is generally more honesty and transparency in fee based Independent advice.

    How are they regulated?
    All financial advisers whether independent tied or multi-tied are regulated by the Financial Conduct Authority FCA under the provisions of the Financial Services and Markets Act 2000. For more information about the FCA visit their website – http://www.FCA.gov.uk/

    Which is best for me?
    There is a myth that Independent financial advice is the most expensive of the options. In actual fact the Independent adviser still has the same commissions available to the client that a tied or multi-tied adviser has, but he also has other options to meet the client’s specific needs. It is for this reason that Accountants and Solicitors are prohibited from referring their clients to anything other than an Independent Financial Adviser by their regulators. Sometimes going to the bank for a financial product can best, but if you can seek independent financial advice first, it might save you just being ‘sold’ the bank’s latest ‘product of the month’.

    A backup plan is the safety net that your business needs. Without one, you run the risk of being left with nothing, but with one you could double your wealth. You can also have more than one backup strategy, for example financial planning will give you multiple options of where you can place your money to protect it. You could also couple this with putting money from your first business into a second- remember ‘If plan A fails, remember that you still have 25 letters left’, but only if you have a backup plan.

    Chapter 4- When Your Backup Plan Back-Fires

    For some of you, chapter 3 (which covered the importance of having a backup plan) may have been like preaching to the converted. You may already have a fall back option in the form of pensions and investments. Hopefully these existing measures will provide enough financial security for you and your family in the future. But what if they do not? Do you really know how well your pension or investments are performing? What do you do if your pension is giving you poor returns and your investments and savings are being eroded by inflation and pitiful rates? Are you, like most people, taking too much risk with your money? What will happen to your financial security when your backup plan backfires?

    In this chapter we will look at the ways in which you can ensure that your existing financial backup plans will deliver what you need in the years to come. Making sure that your backup plan is secure and working efficiently is something that every business owner should do. At the end of the day, you need to have confidence in the measures that you have put into place and you need to be sure that your money is working hard for you. Not doing this is a huge risk to you, your family and your business; Doing so could significantly increase your wealth in the years to come.

    The key to ensuring that your pensions and investments are offering the best returns is to review them. You can of course do this yourself, or you could employ the services of a financial advisor. ‘When building or reviewing your pension or investment portfolio there are a number of factors that will determine your strategy, including the level of risk you are willing to take. This is likely to change through your life, which means your investment strategy will also need to change. Your financial adviser can play a vital role in helping make sure your pension holdings match your risk profile and your investment goals.’ (http://www2.skandia.co.uk/skandia-insights/retirement/Keeping-your-pension-on-track/) Before you can begin to review your returns you need to decide what level of risk you are willing to take; how much could you stand to lose in the first 5 years? What types of savings and investment funds to do you feel comfortable with? Once this has been decided, you can then begin to look at how your funds can be improved upon. All too often people take too much risk. They then end up getting their fingers burnt and revert to cash, where they are currently guaranteed to lose money in real terms, because of inflation.

    We will begin by looking at pensions. Some of this information can also be applied to investments. Pensions are a highly tax-efficient vehicle for long-term retirement investments. However, ‘in April 2006, a streamlined pension regime introduced a number of extra benefits, including the potential to contribute larger sums into your pension fund when the timing is right for you.’ (Skandia) This means that you can ensure that you have enough money put away for your retirement, without having to rely solely on the profits from your business. Until the end of the 2015/16 tax year you can potentially save 100% of your income into your pension, up to a maximum of £255,000, and still benefit from tax relief. You should note that there are some restrictions on tax relief to those who have incomes above £130,000. The definition of ‘income’ is very broad so if your earnings are near this amount you should check your position with a financial adviser. Pensions are a fantastic way of putting away money as a backup plan for your future, but you need to ensure that you are receiving the best rate and are invested into the correct pension for you.

    Now we move onto investments. In many ways, investments are very similar to pensions; you must select the fund which is right for you and gives you the return that you need. You must also ensure that your investments have been selected due the level of risk that is the best for you. Again, you can invest money yourself; however we would recommend that you seek professional, and reputable, advice when doing so. There have been numerous ‘Boiler Room’ scams in recent years, where shares have been sold that did not exist. As a general rule, if sounds too good to be true, it probably is.

    Harry Markowitz, ‘Modern Portfolio Theory’

    Whether you have existing investments or require yours to be reviewed, where do you begin? In 1952 in the ‘Journal of Finance’, Harry Markowitz proposed his theory that diversifying your investments is the key to continually achieving the best returns for any given amount of risk. This ‘Modern Portfolio Theory’ as it was termed, has become a solid basis for financial advice today. It is also the approach that we recommend that you take to your investments.

    Diversification is most certainly the key; by investing your money between a range of funds, you are almost giving your backup plan a backup plan! It means that you are far more likely to receive better returns than if your funds were all in one place. This theory of diversification can be applied right across your finances and is not purely reserved for investments. We mentioned before that when it comes to investments, we would strongly recommend speaking to someone in the know- ideally an independent financial advisor. An IFA will be able to take you through a process that will be able to identify what level of risk you wish to take and then select the best investment strategy for you. For example, at Efficient Portfolio, we take each client through this investment approach:

    However, if you feel that you are savvy with investments and want to organise your own, we would recommend using a ‘platform’. A ‘platform’ is a vehicle that enables you to place all of your investments, regardless of how diversified they are, in one place. This means that managing, maintaining and monitoring your investments is straight forward. You will also be likely to be provided with a fund manager, who will be able to suggest which investments would work for you.

    It is paramount to regularly review your pensions and investment funds, as these could mean the difference between a financially comfortable future or a very late retirement that is full of fiscal worry. The failure of your backup plan is a huge risk to your business, but something that is simple to rectify with the right guidance. Professional financial advice may come at a price, but the risk of losing all of your hard earned money makes it worth it.

    Chapter 5- Don’t Forget Your Key (man) s

    For this chapter we want you to think about what makes your business great. If your company makes profit through sales, how are those sales generated? If you operate a manufacturing firm, how are your goods produced? If you offer a service, where does that knowledge come from? The answer in all of these examples is through your team of people. Your company relies on its workforce, whether they have experience and knowledge, a powerful influence or a skill set which makes them a valuable commodity. Employing the right people is a struggle in itself, but once you have them, your company can become exceptional and outstanding in its field. Once you have these, you need to keep them. You can do this through the benefits which you provide for them, for example a pension scheme (which has been proven to be the 2nd highest ranked financial benefit of working, next to a salary. But this is not the focus of this chapter; We are going to assume that you already know how to retain your steam. So, the question is, what else could go wrong? What would happen if one of your key team members was taken ill for an extended period? What if someone has an accident which prevents them from working? And what about the worst possible scenario, one of your most valuable members of staff dies? What will happen to your business if one, or more, of your key personnel needs time out of the business?

    To put this idea into context, think about this; you insure the building that your business is located in because damages to it would be costly, both to rebuild and repair the physical building, but also so that you do not have to take money out of your company to cover these costs. Likewise, you insure any machinery, company cars, mobile phones, computers…the list goes on. You insure these because you need them in order to operate and because you place a high importance upon them. So why would you not insure the core ingredient that not only makes your business a success, but the aspect of your company that you really cannot do without- your key employees?

    One of the biggest risks to your company is the incapacitation of one of your key individuals. The influential, knowledgeable and experienced personnel within your company make your business what it is. If something happens to them, your business will suffer. Illness and death is something that is out of all of our control. However, there is help out there, which will safeguard you and your company; Keyman Protection

    Keyman (or person) Protection is fundamentally a type of Insurance for your business. When a company wishes to compensate for financial loss that would arise from a serious illness or death of a key individual, this type of insurance can be taken out. The policy intends to cover the business for any losses incurred and enables the business to continue as before. The policy does not cover actual losses, but instead compensates the company with an income or lump sum that has been predetermined.

    In order to show you the importance of Keyman Protection, we would like to share a case study with you. This case study looks at Phillip Carter who was the Executive Director for Chelsea;

    ‘Philip Carter was a successful businessman and executive director of Chelsea Football Club.
    As well as being an executive director of Chelsea Football Club, Philip was the founder and entrepreneurial force behind the Carter and Carter training group.

    Over 15 years, Philip built up his business from nothing to a market value of £500 million. With a personal stake in the business worth £100 million, financial security should not have been an issue for Philip and his family. Tragically in 2007, the situation changed overnight. Returning home from a Chelsea match, the helicopter he was flying crashed, and he died along with his son and 2 others.
    Philip died with no succession policy in place.
    Following his premature death, a number of profit warnings were issued and ultimately the share price of Carter and Carter crashed from a high of £12.75 just before his death, to 85p before being suspended. Bankers lost confidence in the business and the administrators were called in. Unsecured creditors received pennies in the pound, most of the workforce lost their jobs and the £100 million shares he left to his estate were virtually worthless.

    The company did not have life assurance on Phillip. But this kind of cover could have prevented the profit warnings, maintained the share price and kept the banker’s confidence.’

    The late Sir Phillip Carter and his family

    Carter’s tale is certainly a deeply upsetting one. The man that had it all financially was set to provide his family with a lifetime of security and comfort. Then tragedy hit and they were left with next to nothing from his extraordinary business. This is a harsh reality for business owners- one day you can have it all and the next it is taken away from you. Unfortunately in life there are some things that you cannot stop from happening, but there are steps that you can take which will ease, if not eradicate, the financial blow and ensure that an unexpected event does not bring your financial plan crashing down.

    Keyman Protection is essential future planning for your business. The smaller you are, the more vulnerable you become to loss due to sickness and death of a key member. Even larger companies with say three managers or directors would be severely impacted if there was a loss of just one person. A sole trader will cease to exist. Keyman Protection will protect your business and reduce the risk that losses could mean. It could also act as the difference between your family benefiting from your businesses profits or being left with nothing. So let us look at this type of protection in more depth.

    To begin with, we will discuss the types of cost that you could be faced with if a key individual was absent from work for a protracted period. If a key person cannot work, you may require temporary staff to cover their role. This would mean that you have the cost of recruitment, additional wages and training. Taking money out of the business to do this may affect your cash flow, which in turn could lead to you not being able to fulfil all of your customer’s orders or needs. You may then be in a position where it becomes a necessity to borrow funds from the bank. Not only could this be a lengthy process, but you are not guaranteed the loan. After all, if the banks are not confident that you can repay the sum, they will not lend it to you. Even worse, the bank may lose confidence in your company and call in the overdraft. This leaves you in a financial conundrum where cash flow has decreased and profits have significantly dropped. This may sound extreme, but it could easily happen. During this time of difficulty, you also need to consider how many customer you may lose, especially how many of them will be pilfered by your prowling competitors.

    In order to put this into a real situation, we would like to share an example with you. The aim here is to show you how Keyman Insurance can help to prevent a catastrophe.

    Gill is the Distribution Manager for an online clothing company. Gill ensures that all orders are correctly packaged and sent to the customers on time. She also has the managerial duties of organising staff rotas, dealing with employees concerns and she acts as a deputy when the Managing Director is absent. Gill suffers a heart attack and is unable to work for at least six months.

    Thankfully, Gill is one of the individuals who are named on the firm’s Keyman Insurance policy. This means that temporary staff have been recruited to cover Gill’s role and ensure that the customers still receive their orders on time, staff rotas are completed, and the Managing Director still has someone reliable in place to take charge in her absence. Keyman Insurance pays out the sum assured to cover the costs of recruitment and additional wages
    As you can see in the previous example, Keyman Insurance is a valuable protection to put into place, both for you, your business and your family. The people that can be covered by Keyman Protection can effectively be anyone who has a significant impact upon your business. For example, they could be the CEO or Executive, departmental manager, a sales person or a head of a department. As a starting point, Keyman Insurance covers 3 categories of loss;

  • Protection of losses related to the extended period when a key person is unable to work; to provide temporary personnel; and, if necessary, to finance the recruitment and training of a replacement.
  • Protection of profits such as offsetting lost income from lost sales; or losses resulting from the delay or cancellation of any business project that the key person was involved in; or loss of opportunity to expand, loss of specialised skills or knowledge.
  • Protection of anyone involved in guaranteeing businesses loans or banking facilities. The value of insurance cover is arranged to equal the value of the guarantee given by the key person. (http://www.keymanadviser.co.uk/key-man-insurance/)
  • Partnership Protection
    Partnership Protection comes in three main forms; ‘Buy to Sell’, ‘Cross Option’ and ‘Automatic Accrual’. In essence, this type of Keyman Insurance is the same as Shareholder Protection, however this deals with the actual ownership of the business, rather than just shares.

    As the owner of a Company, Keyman Protection should be something that is a strong consideration for you. At the end of the day, the implementation of such a scheme could save you hundreds, thousands and in some cases millions of pounds. Keyman Protection is a safety net that could also ensure that your business is protected for the future. This type of insurance can be incredibly complicated, so we highly recommend seeking professional advice from an independent financial planner. At Efficient Portfolio, we have years of experience dealing with corporate clients, so we are here to help you with your Keyman Insurance.

    Chapter 6 – You Are Not Immortal

    Nothing lasts forever, especially not you. This may seem like a slightly morbid statement, but the truth is that no one, not even business owners, are immortal. You may have worked hard your whole life in order to build your company, but one day you will have to bow out. Age, and eventually death, comes to all of us. They are not pleasant topics to have to think about, but it is crucial that you do.

    In Chapter 1 we discussed Exit Strategies: how and when you should leave your business in order to maximise your profits. This chapter does not aim to repeat any of that; instead this section of the paper will look at how Protection can safe- guard your family when you pass away. We will look at two different elements of Protection that will ensure that your family and your business have a secure future when you have gone. This chapter is not intended to scare you, rather to try to show you how you can achieve some piece of mind in knowing that your loved ones and your business are going to be looked after.

    Like in other chapters of this paper, being prepared is the key to ensuring the success of your business. Mortality is not something that many of us like to think about, but as a business owner you must always be thinking ahead- even if some of the future does not seem appealing. The sixth biggest risk to your business, and your family’s future financial security, is not having Protection in place for the event of your death, or that of your fellow directors. So what exactly can you do?

    The answer is ‘Shareholder Protection’. In terms of ensuring that your business will continue to thrive in the event of your death, this is, in our opinion, the best Protection product to look into. Shareholder Protection Insurance guarantees that in the event of the death of a shareholder, the surviving owners will be given sufficient funds in order to buy the deceased’s stake in the business. By doing this, the surviving shareholders will remain in control of the company and the beneficiaries of the deceased’s estate (i.e. your family) will receive any interest accumulated from the shares, or indeed the profit of the sale of them. Shareholder Protection Insurance will enable your business to continue to be operational and your family to receive a financial gain.

    Colin and Ravi are equal directors and shareholders of a catering company, which they set up 4 years ago. Both of them are involved in the day to day operations of the business,
    even though they employ over 40 members of staff. The two men both have wives and children, but none of the family members have the skills to run a business and the children have no urge to follow in their father’s footsteps.

    Colin and Ravi decide to set up two Keyman Insurance policies in order to protect each other’s lives if the worst were to happen. This would mean that in the event of sickness, incapacity or death, the two families would be looked after and the business could still continue to operate.

    In this instance, Shareholder Protection policies are set up under a business trust with a cross option agreement. This means that if one of them should die, the payment received goes straight into the company and the shares that the deceased owned go to the respective family. Of course, the family have no interest in the business so do not want the shares, they want the money. Conversely, the surviving business owner wants the shares, not the cash. This is where the Cross-Option Agreement comes in to play. This agreement means that if one party is dissatisfied with the outcome and wishes to contest it, the other party must oblige. In this case, both parties are eager to do this, so that the family get the cash and the remaining business owner receives the shares. The family are financially comfortable and the surviving business owner has full control of the company. Everyone is happy.

    There are two perspectives to consider when looking at the benefits of Shareholder Protection Insurance. Firstly, if you have a business partner, or rather fellow shareholder, you will benefit if this type of insurance is in place. Imagine that your co-owner falls ill or even dies. By having Shareholder Protection Insurance in place, you will be given a lump sum which you can use to buy their shares and keep control of the business. By having complete ownership of the company you make the decisions. You can decide what is best for the company, for example you may want to replace the deceased or incapacitated Shareholder and bring someone new onboard.

    The terms of the Shareholder Protection Insurance state that the deceased Shareholder’s family will not be involved in the running of your company (they will sell the shares to you, so they benefit financially and you gain control of the business). This is reassuring, as you can be safe in the knowledge that someone who is not familiar with your business will not be in control. You should also take comfort in the fact that you have been able to purchase the shares in company without having to borrow money. This means that you have put the company in a financially strong position, i.e. no debts to repay or loans from the bank that are hanging over your head.

    In the second perspective, imagine that you are the Shareholder who is ill, or has sadly passed away. Shareholder Protection Insurance will make sure that your family will receive a fair value for your interest in the business. This type of insurance will give you peace of mind, as the sale of your shares will realise the true value of your stake in the company. By having Shareholder Protection in place, you are also preventing any added pressure on your family in the event of your death. They will not have to try to find a buyer for your shares in the business, as they will automatically be obliged to sell them to the fellow shareholders. All of the hard work that you have put into your business will be paid back to your family.

    There are also benefits that can be attributed directly to you from Shareholder Protection Insurance. Say for example you fall ill. The last thing you need is the added worry of financial matters, which could hinder your recovery. This type of Protection will eradicate this, meaning that you can get well without any stress. You can also be safe in the knowledge that you are preventing the company ending up in financial jeopardy, caused by them having to borrow funds to buy your shares. Finally, Shareholder Protection will enable to you to retire with no money worries-as long as you are a shareholder, your family will always benefit.

    As you can see, Shareholder Protection does not only benefit your family, but it also benefits your company- whether you pass away or if a fellow Shareholder dies or is taken ill. This type of Protection is something that we would recommend to all business owners. However, there is another type of Protection that is just as important to put into place- Relevant Life Cover.

    Relevant Life Cover may sound like any other Life Insurance policy, but it is in fact very different. Relevant Life Cover is a way in which an employer, in this case a Business Owner, can set up an alternative form of Life Cover for an employee, without having to register in a ‘Death in Service’ scheme. The employee’s family will be paid a lump sum if they were to pass away whilst they are employed by your company. A key factor of this type of coverage is that it is incredibly tax efficient. But how is this different from the conventional schemes?

    With the traditional ‘death in service scheme’ there are certain features which may make it unsuitable for everyone;

  • ‘Death in Service’ is not normally available to companies with fewer than 5 employees.
  • For high earning employees with large pension pots, this type of benefit may take them over their Lifetime Pension Allowance. Consequently, your employees could end up simply paying for their own Life Coverage product with their post-tax money.
  • This type of Protection is supplied on a group basis, which means that everyone has to be given the exact same benefits. This can make it difficult to offer your most valued employees, as it does appear to be a ‘special’ benefit for them.
  • Relevant Life Cover differs from ‘death in Service’ in many ways, most notably that this product is available to everyone- not just medium to large companies. Relevant Life is suitable for businesses of all sizes and is available on an individual basis, meaning that if you own a very small company with only 2 employees, you can still make sure that you are protected.

    Relevant Life is also the best type of Protection for high earners who have substantial pension pots. With traditional ‘Death in Service’ schemes, this benefit counts towards their Lifetime Allowance. However, Relevant Life offers a number of tax advantages, because the lump sum benefits do not form part of the employee’s annual or lifetime pension allowance.

    This type of protection offers benefits to both employer and employee. For example, for the employee, they can be confident in the knowledge that if the worst was to happen, a lump sum would be paid out to their family, or nominated beneficiary. There is also of course the benefit of the Relevant Life not being included towards your employee’s Lifetime Pension Allowance, which we have already looked at. But what about the benefits to you? Well, there are several;

    The biggest bonus for you as an employer is the tax efficient nature of Relevant Life Coverage. The policy premiums are paid for by the business and are normally exempt from National Insurance contributions, both from employer and employee. The policy premiums that the company pay out can also be treated as a business expense. Please note that this is only the case if this is qualified when calculating your tax liability. However, under normal circumstances, companies could make up to ‘60% tax savings on gross premiums when compared to a traditional Life Cover Policy, making it a tax-efficient way for you to arrange Life Cover for an employee’. This is simply because of the fact that the premiums are paid for by the company, not the individual.

    Both Shareholder Protection and Relevant Life Cover can benefit your company. None of us are immortal, so we need to prepare for the worst. With both of these types of Protection, your business and family would be financially cared for if you were to pass away. Protection can be a complicated subject and you must make sure that it is right for you and your business. At Efficient Portfolio we have a dedicated team who are experts when it comes to Protection for individuals and companies alike. If you would like to find out more, we would be delighted to hear from you.

    Chapter 7- Do Not Over Pay the Tax Man!

    Tax. The word that strikes fear into even the most honest and hard working of us. It is something that we would all like to avoid, but it is inescapable in most situations. Of course there are some exceptions, for example ‘there are certain sorts of income that you never pay tax on. These include certain benefits, income from tax exempt accounts, Working Tax Credit (WTC) and premium bond wins. These income sources are ignored altogether when working out how much Income Tax you may need to pay’. (http://www.hmrc.gov.uk/incometax/basics.htm) Realistically as a business owner you are not exempt; you will pay tax on the return of your capital and on the additional profits of your venture. Despite tax being a ‘universal truth’, there are ways that you can reduce your tax bill. The rule is, pay yourself before you pay the Tax Man.

    In this chapter we will look at ways in which you can reduce your tax bill. After all, why fork out more money than you have to? A huge risk to your business is that you pay too much tax, when you really do not have to. The solution, and one that could make you money, is to take funds out of the business and place them into more tax efficient vehicles. These ‘vehicles’ are called ‘tax wrappers’ , which are defined as ‘tax breaks that an investor can ‘wrap’ around their investment, so that they can are sheltered from paying some or all tax on it’.(http://www.uswitch.com/investments/investment-glossary/) We would suggest a successful business owner gives consideration to four different Tax shells; pensions, Enterprise Investment Schemes (EIS), Venture Capital Trusts (VCTs) and Seed Enterprise Investment Schemes (SEIS). However, before we look at these, let us take a look at the most commonly known Tax Wrapper, and one that you should have in place whether you are a business owner or not- the ISA.

    The ISA wrapper is simply a (virtually) tax free shell for savings and investments. This tax year (from 6th April 2013 to 5th April 2014) you can invest £11,520 into an ISA, of which half can be in a Cash ISA. Ironically, ISAs are one of the most commonly known financial products on the market, yet the vast majority are confused as to what they actually are. The general misconception is that Individual Savings Accounts (ISAs) are somewhat of a complex beast, but that really is not the case. To put them in simple terms, they are a tax free wrapper into which you can place either cash or shares.
    ISA’s, introduced in April 1999 in order to replace PEPs and Tessas, come in two forms; Cash and Stocks and Shares.

    Cash ISAs
    Cash ISAs are simply savings accounts. However, unlike a traditional savings account where a percentage of the interest accrued is taxed and given straight to the Government, Cash ISAs are Tax free. This means that it is rare for a standard savings account to pay a higher rate of interest than an ISA.

    Cash ISAs, just like the normal savings account, come in a variety of types, for example ‘instant access’, ‘fixed rate’ and accounts with base rate guarantees. This means that there is an ISA out there to suit nearly everyone’s needs.

    Stocks and Shares ISAs
    Stocks and Shares ISAs have many similar qualities to their Cash ISA cousins, for example they are tax efficient in that any profit made is exempt from Capital Gains Tax. There is also a limit of how much you can invest in this type of ISA (as I mentioned before), however, double the amount can be invested into a Stocks and Shares ISA compared to a Cash ISA.

    Stocks and Shares ISAs are usually held in collective investments, such as Unit or Investment Trusts. A fund manager will select a variety of shares and the value of the investment will depend on the collective performance of these. There is of course an element of risk involved with Stocks and Shares ISAs, as the amount that you stand to make can fluctuate and is never guaranteed.

    Regardless of the type of ISA that you opt for, there are some general rules and tips to follow. We have briefly touched upon how ISAs run along the same time scales as the Tax Year; this means that any savings or investments must be made by 5th April each year, as unused allowances do not roll over. As a rule, an ISA would usually be the first place for any savings to go, as after the tax year ends, any savings or investments stay within the tax-free ISA for the future, where they will continue to grow tax efficiently.

    ISAs are virtually Tax free vehicles once your funds are inside them (this includes funds that are taken out of the). However, it is worth bearing in mind that there is no tax break for you money whist it is going in to an ISA. See the table at the end of this chapter to see how ISAs compare to other Tax shells.

    Pensions also offer tax free growth in the same way as ISAs, but with some significant differences. When you invest money you can claim back the income tax you have paid on this income (as long as you have paid it, and also subject to a current cap of £50,000 per annum). So as a basic rate tax payer, an £800 investment instantly grows to £1,000. That is an instant return of 25%, not bad for day one. As a higher rate tax payer, the picture looks even more attractive. Make an investment of £600 net of tax, and it turns into an investment of £1,000 by the time you have completed your tax return. That is a 66% return on your investment without any actual growth. Again, that sounds quite compelling! So what is the catch I hear you ask?

    There are two catches with pensions. Firstly, you cannot access the money until you are at least age 55, although given you probably want to stop working at some point in the future and will want an income; this should not be an issue as long as you have some short and medium term savings as well. The second catch is that you can then only get access to 25% as a tax free lump sum. The remainder has to provide you with a taxed income. This highlights an important point. Pensions provide tax deferral, not tax free income. This does however mean a higher rate tax layer can defer income to a point where they are a basic rate tax payer, and likewise a basic rate tax payer can draw out some of their income tax free as a result. Whilst they are not completely tax free, when you also add in the growth on the tax you would have otherwise paid, they are extremely tax efficient long term savings vehicles. Just make sure you invest in a decent one. There is a lot of rubbish in this sector, and particularly those pensions set up prior to 2001, so before you plough lots more money into a subordinate scheme, it might be worth seeking advice on the best pension pot to use.

    As a business owner, we understand that your time is precious, so pension planning may have been pushed to one side. However, a solid pension will provide a comfortable and secure retirement for you and your family in the future and can save you tax now. Therefore, a pension is something that you must consider. You may have heard about ‘Automatic Enrolment’ in the press last year. If you have employees, this new legislation, which started in 2012, means that all employers are obligated to run and contribute to a company pension scheme. Your duty is to select a scheme for your company, which can be done with the help of an Independent Financial Advisor. If you have not already selected a pension fund, this an excellent opportunity to also look at your own, tax efficient, pension.

    Before we begin to look at the options available to you, we would like to highlight some restrictions that have come about because of a simplified tax regime. This simplified regime actually allows business owners to make the most of their pensions arrangements;

  • There is limit of £1.5 million placed upon an individual’s savings (correct for 2012-13). The annual allowance is currently £50,000. Contributions in excess of this are subject to tax.
  • The percentage that you pay as tax payer (e.g. Standard, 40% or 50%) affects how much you can claim as additional tax relief.
  • Tax free lump sums of up to 25% of your total pensions savings can be drawn.
  • Benefits may normally be drawn after the age of 55, but the lump sum must be drawn at the age of 75.
  • Members do not have to retire or leave service in order to take pension benefits.
  • There is no statuary retirement to purchase an annuity.
  • There are no restrictions on transfers between pension schemes
  • Pensions are the most tax efficient way to fund your retirement and there are many options available to you as a business owner. The first options we will look at are Small Self-Administered Schemes (SSAS). ‘A SSAS is a company scheme where the members are usually all company directors or key staff.  A SSAS is set up by a trust deed and rules and allows members / employers, greater flexibility and control over the scheme's assets.’1 Contributions to this scheme have no limit, whether they are made by the employee or employer. The trustees, usually the business owner and the key personnel, have control over the scheme’s assets at all times. They also decide how the payments are invested. ‘SSAS registered with HMRC may enjoy tax-exempt status, all investments made will be free of Capital Gains Tax, and contributions to the SSAS will receive tax-relief (if contributions are made by a "Relevant UK Individual"). Basic rate tax relief can be claimed by the SSAS itself, and any higher rate tax would be claimed through the member's tax return. The sponsoring employer can also pay contributions to the scheme and may obtain tax relief on the contributions. Tax relief on personal contributions is calculated at the person's marginal rate of income tax, and for company contributions it is calculated as the company's marginal rate of corporation tax. Third party contributions may be made in some circumstances.’ (https://en.wikipedia.org/wiki/Small_Self_Administered_Scheme)

    A pension can also form part of your ‘Exit Strategy’ (see Chapter 1). Basically, because there are no limits as to how much you can contribute to your pension in the final year prior to your retirement, you can invest as much as possible. If you have planned to sell your business, paying a large sum into your scheme will reduce the capital gains tax on the sale of the company. Note here however, that you cannot exceed your lifetime limit without incurring a tax penalty. In the same way, there are such things as ‘pension mortgages’, which allow you to make interest only payments on the mortgage while at the same time paying into a pension. At the end of the mortgage term, you can use the tax free lump sum from your pension to pay off the mortgage. This means that when you sell the business, you will not have any overheads to pay off with your profit.

    So what other forms can pensions take on? We will concentrate on three here, but there are more!

    A pension can also form part of your ‘Exit Strategy’ (see Chapter 1). Basically, because there are no limits as to how much you can contribute to your pension in the final year prior to your retirement, you can invest as much as possible. If you have planned to sell your business, paying a large sum into your scheme will reduce the capital gains tax on the sale of the company. Note here however, that you cannot exceed your lifetime limit without incurring a tax penalty. In the same way, there are such things as ‘pension mortgages’, which allow you to make interest only payments on the mortgage while at the same time paying into a pension. At the end of the mortgage term, you can use the tax free lump sum from your pension to pay off the mortgage. This means that when you sell the business, you will not have any overheads to pay off with your profit.

    So what other forms can pensions take on? We will concentrate on three here, but there are more!

    Self-Invested Personal Pensions (SIPPS)
    As the name may suggest, a SIPP is a sort of ‘do it yourself’ pension, where you can select the investments that your money is placed in to. A SIPP will allow you much greater investment freedom than many other pension tax-wrappers out there. There is no Capital Gains Tax to pay on any profits that you make from a SIPP and you can take 25% of the pot as a tax free lump sum upon retirement. SIPPS will give you freedom and save you tax, but they can be quite tricky to administer. If you are interested in this type of product, always seek professional advice.

    Salary Sacrifice
    Salary Sacrifice does what it says on the tin- you give up a part of your salary. With the sum that you have ‘sacrificed’ you can buy non-cash benefits, such as child-care vouchers, a lease car or a pension. Because these are regarded as non-cash benefits, both the employee and the employer can make National Insurance savings (i.e. this sum is deducted from your salary, so you pay a lower percentage of tax). The employer can also pass on the savings that they have made by having a lower National Insurance bill as a bonus contribution to their employees’ pension plan. This is a great scheme for the employee and employer alike, as you will both save tax and the overall amount contributed to the company’s pension pots will rise at no extra cost.

    Hopefully that has given you an insight into pensions. As you can see, they can be quite complex beasts, so it is a wise decision to ask for professional help with your pension. The final section that we will look at is Enterprise Investment Schemes. These are slightly more sophisticated than a standard pension, but still offer a tax efficient mechanism for you to save your money.

    Enterprise Investment Schemes (EIS) are investments that receive little press; however they are fantastic tools when it comes to reducing Income Tax, Inheritance Tax (IHT) and Capital Gains Tax (CGT).

    EIS offer investors the following tax incentives.
    Income tax relief - Income tax relief at a 20% rate of tax on the amount invested in qualifying investments of up to £500,000 per annum, as long as the investment is held for 3 years. For example a £10,000 investment would attract £2,000 income tax relief.
    CGT Deferral Relief - Deferral of capital gains (no limit) on any other assets, by reinvesting all or part of the gain into an EIS company within one year before, or three years after, the gain accrued.
    CGT Free - No Capital Gains Tax payable on disposal of shares after three years, or three years after commencement of trade, if later, provided the EIS initial income tax relief was given and not withdrawn on those shares.
    Loss Relief – Where shares are disposed of at any time at a loss (after taking into account income tax relief). Loss relief is applied at an individual’s highest marginal rate of income tax in the year in which the loss is crystallised.
    Inheritance Tax Exemption – EIS Investments are generally exempt from Inheritance Tax after two years of holding such investment.

    So the tax incentives look very attractive in the right situations, but you also need to consider the risks of the investments, because typically, EISs are high risk investments. They are investments into a single unquoted qualifying company, which by its very nature is almost always extremely high risk. Some try to reduce risk by investing in companies that hold property assets such as pubs or farm shops, but they still offer high levels of risk.

    There are however some that have managed their risk in more creative ways. One example is investing in companies that benefit from government backed schemes. One such example is a Solar EIS where the returns are provided by the government’s feed in tariff on solar (PV) panels. As this tariff is guaranteed by the government, the risk level is considered much lower. Finally, where the EIS is targeting the tax relief specifically, there are a couple of creative EIS schemes that have Revenues & Customs approval and manage to provide more conservative returns whilst minimising the risk.

    We believe that EIS investments serve a purpose for many investors, especially business owners. However some of the situations where they provide most value are as follows;

    Inheritance Tax reduction
    People who are looking later in life to remove some of their capital to outside of the IHT estate for IHT purposes without giving up the right to the capital or income. Here the lower risk IHT specific EIS arrangements work very well. They can remove capital from the estate after just 2 years (as opposed to 7 years when gifted to someone or a trust) whilst retaining the right to the income and also the access capital if they need it.

    Creating a trust fund
    Getting large amounts into a trust can create a 20% tax charge paid at the point of gift, with a further tax charge payable if the donor dies within 7 years. By investing this into an EIS first, waiting for 2 years, this money can pass into the trust free of IHT immediately.

    Capital Gains Tax (CGT) Deferral
    Where someone has created a CGT liability by selling an asset, this can be deferred and then redeemed gradually in order to use multiple annual allowances.

    High earner investment
    Where someone has fully funded their pension and ISA, a variety of Venture Capital Trusts
    and EISs can provide a more diversified portfolio of investments for the future, whilst giving a number of tax breaks.

    VCTs and SEIS are the other two Tax shells that are available to you. As you can imagine, as SEIS is very similar in structure to its cousin the EIS. There are however some slightly different Tax breaks involved, which are shown in the table at the end of this chapter. VCTs can offer Tax breaks, with many additional advantages over pensions, as long as they are managed correctly.
    VCTs offer investors the following tax incentives.

  • Income tax relief – Individuals who subscribe for new ordinary shares in VCTs up to £200,000 per tax year, qualify for 30% income tax relief, provided the shares are held for at least five years. In other words, someone investing £100,000 will receive £30,000 tax back through their tax return.
  • Tax Free Dividends – any dividend received by individuals aged at least eighteen in respect of ordinary shares in a VCT is exempt from income tax, so a 3% dividend is equivalent to a 5% dividend from any other share for a higher rate tax payer.
  • Capital Gains Relief – Gains accruing to individuals are not chargeable gains for tax purposes.
  • So, what is the difference between a VCT and a pension?

    Tax breaks; VCTs offer 30% income tax relief on the way into the investment, whereas a pension can offer 40%. However, when the VCT is sold after 5 years, the proceeds are tax free, whereas 75% of the pension is taxed as earned income (either 20% or 40% depending on your income). So tax wise, the VCT is actually better.

    Access; Whilst a pension cannot be accessed until 55, and then only 25% as a lump sum with the rest being taken as an income, the VCT is all available after 5 years, so that you can do with it as you wish.

    Why are VCTs high risk?
    Three of the biggest criticisms of VCTs in the past have been;
    a) Their exposure to small high-risk companies; and those that have provided good returns have been more than offset by those that haven’t.
    b) That they needed to be held for a long time (10 years) to see any real growth.
    c) Selling the VCT before the manager is ready to wind it up has led to poor returns, as there is still very little secondary market for VCT shares.

    And why are today’s any better?
    Whilst there are still plenty of much higher risk VCTs out there, some VCTs available today aim to address these issues in the following ways;
    a) Reducing the risk of the underlying investments by mainly holding asset backed investments (such as companies that own property as part of their business).  
    b) Some VCTs are being set up with specific timescales for exit; typically 5-6 years, as this is when they realise investors will want to get out, and potentially reinvest for more tax relief.
    c) Offering sensible buyback facilities so that you are guaranteed to have a secondary buyer.
    d) A VCT has up to 3 years to get 80% of the funds into qualifying investments, so this gives them the opportunity to hold lower risk investments for 3 of the 5 years.

    Money In Once In Money Out IHT
    ISA No Tax Break Virtual Tax free growth Income Tax free IHT can be applied
    Pension Tax relief going in Virtual Tax free growth 25% Tax free lump sum. Rest Taxed but as you are retired, it is likely to be at a lower rate. Pre-retirement, no IHT.

    Post- retirement- depends on how you took your pension.

    EIS 30% tax relief, if held for 3 years Free of Capital Gains Tax if held for 3 years. Defer existing CGT Tax free and can have full capital back after 3 years (subject to growth). Loss relief at 35% Free of IHT after 2 years
    SEIS 50% Tax relief if held for 3 years Free of Capital Gains Tax if held for 3 years. CGT on other gains at 20% Tax free and can have full capital back after 3 years (subject to growth). Loss relief at 35% Free of IHT after 2 years
    VCT 30% Tax relief if held for 5 years Virtually Tax free growth if held for 5 years Tax free and can leave full capital after 5 years IHT can be applied

    Over paying the Tax Man should be avoided at all costs! Not only are there tax efficient ways to avoid your company losing money unnecessarily, but some of these ‘wrappers’ can also make your money increase in value. Taxes saving plans, such as ISAs, Pensions, VCTs, SEIS and EIS schemes are a must for you and your business. We appreciate that some of them can seem complicated and daunting, that is why we recommend that you let a professional do the hard work for you. If you would like to more about how to make your company tax efficient, or how to save for your future, we would love to hear from you.

    Summary

    As a business owner you are in control of your own destiny. In taking the brave step of setting up and running your own company, you are already used to risk, but why take more than you need to? We have covered the seven biggest risks to you as a business owner in this paper, which we hope has been of a benefit to you. To summarise, let us look at those risks again:

    1. Start With the End in Mind

    Not having an Exit Strategy is a huge risk to your business. You need to understand when your business is at its most profitable and when you should walk away from it. A good Exit Strategy could mean the difference between doubling your wealth and leaving your business with nothing.

    2. Know Your Numbers

    A good business owner must have a firm grip on how much profit and how much loss their company is making. You may employ an accountant, but not knowing how your balance sheet works could devastate your business. Equally you must firmly cement in your mind how much money you need to be conformable in the future. At the end of the day, this is one of the key reasons that you set up your business.

    3. If plan A fails, remember that you still have 25 letters left

    Make sure that you have a back-up plan. Business owners that fail to have this safety net usually fail. You can cover yourself in two ways: firstly, by taking money from your main business and putting into a second company that runs independently. This means that if one fails, the other can support it. Secondly, use financial planning to make sure that you have a diversified spread of wealth- different pots, investments and accounts will decrease your risk of financial failure.

    4. When Your Backup Plan Back-Fires

    When your back-up plan is not delivering, it is time to review what you have in place. Your business is at risk if you become complacent and fail to regularly check the financial products that you have in place.

    5. Don’t Forget Your Key (man) s

    Your business would not be successful if it was not for the people that make it what it is. Looking after your key members of staff is one thing, but what if something happens to them like long-term sickness of even death? Failure in safeguarding yourself against the unexpected is a massive risk to your business. Key Man Insurance is a protection product that will ensure that if you lose your support team, you can still successfully operate as a business.

    6. You Are Not Immortal

    Planning for the future is a must to business owners, even when it is thinking forward towards unsavoury subjects like your own death. Unfortunately, you must think about it and make provision for your company and your family. If you do not, your business and loved ones could be left with nothing.

    7. Do Not Over Pay the Tax Man!

    Paying tax unnecessarily will cost your business money, so do not do it! Make sure that your business is tax efficient and that your savings, pensions and investments and too.

    If you would like to talk to us about any of the issues raised in this document, we would be delighted to hear from you.

    Efficient Portfolio
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    This document was produced by the team at Efficient Portfolio Ltd. At no point in the document is advice given to any reader.

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