Thinking ahead: three IHT solutions that don’t compromise on return

How can I do the best for my children? That question is never far from a parent’s mind. In the early years, you focus on getting them started. Food and warmth, love and guidance, these are all important. As they reach adulthood, you want to be there when needed, but you’re careful not to ‘interfere’. At last comes the stage when you realise they are better than you at almost everything. A beautiful feeling!

With luck, your financial situation has matured in a similar way. The early days were scrimp and save, and the outgoings were high, but now you have time to think. How and when is it best to pass on wealth? For many people, that poses a dilemma: do it too early or leave it too late. Fortunately, private company investing offers a special case of having your cake and eating it.

The secret is very simple. Private company shares are completely free from inheritance tax after just 2 years, providing that the shares qualify for Business Relief. By holding wealth in private companies you can escape the pressure that many parents feel to pass on wealth early to avoid significant IHT payments.

You can also pass on parts of your private company portfolio whenever you want. The IHT-exemption remains in place as long as your beneficiaries still hold the shares. This helps to make private company investing a uniquely attractive option for far-sighted parents.

What are the drawbacks of a private company portfolio? Private companies tend to be smaller than listed companies, and that means higher volatility. In other words, any one of your private companies could show rapid growth or shrink equally rapidly. Being small often means relying on fewer customers, fewer experienced managers, and a narrower product. Diversifying is the obvious way to control that sort of risk, so most investors tend to spread their private company portfolio as widely as possible.

Rockpool is one of the handful of firms that help investors build a diverse private company portfolio. Most investors simply use our Private Equity Portfolio Service. It’s no more difficult than opening an investment account for a listed portfolio. You decide how much to invest and how diverse the portfolio should be. We do the rest. It is a bit more gradual though. A typical listed portfolio could be built in a day or more usually over a few days or weeks. With our private company service, you would expect to add six companies per year.

We do have some investors with more specialist tastes. They can lend on a company-by company basis, almost acting as their own investment manager. They can even use our Corporate Inheritance Tax Service to deploy cash through their own private company, acting rather like a bank. This route appeals mainly to successful entrepreneurs, people who are comfortable being in the driving seat.

Liquidity is a big issue for some investors. The beauty of a listed portfolio is that you can typically sell it at short notice. Private companies tend to follow a 3-5 year cycle from investment to sale, so it makes sense to see your private company portfolio as a gradually maturing pool. As long as you want to keep investing, you roll the proceeds of each sale into more companies. That way the IHT exemption is preserved. On the other hand, if you need cash for other uses, every sale adds to your accessible pot.

The same applies to the beneficiaries of your estate. After inheriting the private company portfolio, they would expect to cash in gradually over a few years. If you like, it means them taking a bit of time to enjoy the 40% IHT saving! Or maybe they’ve learnt from you and are already building their own private company portfolios. If that sounds too slow or too complicated, we have a very simple Inheritance Tax Service where beneficiaries can usually liquidate the whole pot within three months.

Beginners are sometimes worried that their private companies might be hard to sell at all. This is where we meet the world of private equity funds. Love them or hate them, no-one can deny their appetite for buying private companies. For our private company investors, the challenge is often to hold on to their companies long enough.

In the strange financial world we are living through, it’s hard to earn an inflation-beating return on investing. Quantitative easing and related policies have squashed interest rates and yields on public companies. Here, private companies can offer an attractive alternative. They’re harder for investors to find, so they tend to pay more for capital. 

When all is said and done, the question is simply this: stick with the mainstream listed portfolio or steer your family wealth like the super-rich. Wealthy families have always invested in private companies. There’s no reason why you shouldn’t join them.

Investing in smaller unquoted companies may not be suitable for you. Your capital will be at risk and there is no guarantee of any return. You may not be able to sell your investment when you want. Tax benefits depend on personal circumstances, the circumstances of the company and on rules and regulations. All of these could change, removing tax benefits that you expected to enjoy.