Many people in our industry contemplate setting up their own agency. The rewards both financially and emotionally are high if you succeed and even the journey can be fun even if you don’t arrive at your destination. What is the worst that can happen? You lose some money and you go back to working for someone else.
First the health warning: 8 out of 10 start-ups fail. But that should not stop you trying – after all, life is not a dress rehearsal and you don’t want to look back when you are older and wish ‘if only…'
The key thing is to mitigate the risks and maximise your opportunity of success. Over the next weeks I will be sharing tips I have learnt over the last seven years that I wish someone had told me when I was contemplating leaving the comfort zone of working for the Saatchi’s after 15 years.
Tip number five: Make sure you know all about Entrepreneurs Relief
Tax? You are a free spirited ad man/woman eager to launch yourself on an adoring marketing community – why on earth should you have your nose in something as mundane as the tax system. Is that not why you have an accountant?
The opportunity to take advantage of the perfectly legal allowances and incentives for new start-ups could impact on how you structure your agency and some of the strategic choices you make. I should caveat this by saying I am not a tax specialist and you should take professional advice, but I was asked by the Treasury Minister to advise the Government on how to promote some of their schemes to potential entrepreneurs.
George Osbourne is not everyone’s cup of tea but he has been extremely helpful to start-ups and in this tip I am going to focus on Entrepreneur’s Relief which means if you are a full time employee and own at least 5% of the shares in your agency for at least one year then any capital gains tax from a future sale is reduced from 28% to only 10%. Osbourne increased the maximum lifetime allowance per individual from £1m to £10m. This is not widely understood, but is a phenomenal incentive for people to set up their own agency and grow its value.
Once you build your business to £1m net profit (more formally known as PBIT = Profit Before Interest and Tax) then typically for an ad agency each £1 of profit = £7 of potential value when you sell your agency. This is known as the ‘multiplier’ but which can vary depending on the uniqueness and desirability of the agency in question.
So let’s take an agency which makes £2m PBIT at a multiple of 7 and sells for £14m:
The founders will have needed to have recruited a second tier of management in order for a buyer to want to acquire the agency and for them to be motivated to build the business going forwards. So usually 15-20% of the shares will need to have been allocated in the form of Options Pool.
Let’s assume four founding partners own the other 80%, with each one receiving therefore £2.8m from the sale. Assuming they had owned their shares for at least three years they will be entitled to Entrepreneurs Relief of 10% which means they will get after-tax £2,520,000. (The technicalities of how options work means that in practice they will get more than that, but let’s keep the maths simple here). I should also add that whilst under-paying yourself might be useful for cashflow purposes when you start up, in terms of your net profit at the time of a sale the buyer will base it on you being paid a commercial rate – so you might as well pay yourself properly.
Now if the founders had instead been working as a paid employee for five years and doing extremely well, earning say a bonus of £100,000 each year (and how many people do you know who get that?) they will have after tax and national insurance £265,000 on top of their salary to show for all their toil.
In short, in the above example you would be 10 times better off after salary by having shares in your own business rather than staying on the salaried tread mill.
Next week’s tip will be the importance of understanding other aspects of the tax system.
If you want to hear about the high and lows of our launch you can read it here
Tip no 1: treat yourself as you would a client
Tip no 2: set up with a partner you know and trust
Tip no 3: invest in good advisors from day one
Tip no 4: never ever give away equity