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Passing on a family-run firm to children should be treated as a planned process

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While it can be hard to envisage handing over responsibility for your business to someone else, it’s essential owners think about the long-term future of their business in good time. Peter Crush outlines some of the options

With 40 per cent of small businesses unlikely to make it to their fifth birthday, according to a study by Ormsby Street, it’s no surprise the very business of staying in business is an all-consuming one. But while simply surviving can seem like an achievement, failing to make decisions around the longer-term future could be just as damaging to a small business’s ongoing longevity.

Whether it’s passing on a business to children, selling up to an outside buyer or facilitating a management buyout, succession planning is often the elephant in the room. “It’s a messy subject,” says Nichola Ross Martin, specialist SME advisor. “That’s because there’s no ‘right’ way of doing things; it depends on the sector, and the mindset of the owner – all of which conspires to make it not thought about as strategically as it should be.” 

Because most small firms are family-run, she argues that the default avoidance position many owners adopt is expecting to pass their business on to the next generation. Almost half of UK SMEs hope to do just this, according to Close Brothers Asset Management, yet it’s a strategy which the data suggests is high-risk, with only 30 per cent of family firms surviving as a second-generation business, falling to 10 per cent for third-generation firms. Familiarity with the business, it seems, supersedes having people with the right skills. 

When bloodline rather than business acumen rules, even bodies supporting family-run firms argue it’s a mistake. “Succession has to be thought of not as a point in time, but a process,” argues Elizabeth Bagger, Executive Director of the Institute for Family Businesses. 


“The process must always be about answering questions like ‘what are we in business for?’ and ‘what must we do to achieve our plans?’ Framing it like this forces owners to assess the skills they have or don’t have, and who might need to come onboard. Only then is the emotion removed, and bosses can look at other solutions like employee-ownership, new management, buyouts or the family taking a side role on a family board.” 

Family failings


The worst plan she says, is simply to assume family will take over, as those who are in family-run firms agree. “I went to university, did a marketing degree and had no intention of going into the family business,” admits Scott Dixon, 30, now third-generation Director at The Flava People – a marinades, glazes and sauces firm originally selling to butchers, but now building a retail brand. “My dad was not far from deciding to sell up completely, but it was the appeal of developing a new consumer brand, of using my marketing skills, that brought me in. I was the skill the business needed, and it just happened to be in the family.”

This clear strategic direction saved the firm from being sold to new owners, has re-ignited his father’s enthusiasm to stay in the business and, as a result, Mr Dixon says he’ll take a business-first decision about its next phase rather than assuming a family-run model. This includes, he says, whether it goes employee-owned. “It’s likely we’ll be seeking funding soon so, actually, the next move could be creating shares,” he said.
The specific succession option that owners pursue is, of course, influenced by their own aims too. Bosses wanting to sell up and retire in the sun may simply seek a simple trade sale. Meanwhile, surrendering most of the business to a buyer, but retaining some equity and decision-making power, could favour those who want a partial exit, easing themselves out gently. 


“Two-year earn-out options are often popular with new buyers or management buyouts (MBOs) because new owners can feel more confident the founder is still there to help them out if issues arise that they haven’t got enough experience about yet,” says Peter Gray, Partner at Cavendish, a consultancy that helps businesses find buyers. 

He says firms often don’t have an ‘exit review strategy’ and as such they can fail to realise what new owners may want. “It’s equally likely an MBO could want a clean break,” he says, “with the founder out of the way, or as a non-executive director, to allow them to pursue their own plans. Owners may have to decide if they accept this as a selling condition.”

Selling tips

 

If potential buyers sense they have the upper hand, owners may not have much choice if they just want to sell. Mr Gray recommends bosses do as much as they can early to ensure they barter as equals. “Selling is its own science,” he says. 

“Most owners assume they can value their business using the standard multiples of profit, asset values, discounted cash-flow calculations, but the reality is rather different. They have to demonstrate worth in other ways: for instance that they’ve divested themselves of responsibility for their biggest clients, to prove the business will survive without them. This involves building up a team of people, any of whom could step up as CEO.” 

According to Mr Gray, the best brokers will help plant stories with local papers to raise the profile – and hopefully the price – of the firms they work with, but that doesn’t stop bosses needing to do their own due diligence. 

He adds: “Sole traders should think about becoming limited companies, and buyers typically want at least three years’ accounts,” he says. “Too often, businesses go up for sale when sales have spiked and the business is in decline. Those serious about selling need to do so when sales are rising, so they have to pick their moment more strategically and work to that, not wait till they’ve got old.”


He argues that succession needs to be thought about three to five years out to present the firm in the best way. 

Perfect timing

 

“If MBO owners want to keep the boss on – normally another two years – then this is another aspect of the timing that needs factoring in,” says Ms Ross Martin. “To ensure bosses are fully free, they might need to start planning many years ahead of their planned exit date.”

Tax concerns muddy the water even further – trading businesses qualify for 100 per cent relief from inheritance tax via business property relief but need to be unlisted. Relief from capital gains tax may exist when bosses transfer their business to a limited company in return for shares, while entrepreneur relief (a lower rate of capital gains tax) can be had on the disposal of assets too – but only if shareholders meet strict tests (such as being an employee), for a full 12 months prior to the sale. 

Other considerations include whether firms need to convert their business into shares (and what type – there is more than one HMRC approved scheme), and how they apportion the amount that have voting rights. ‘Messy’ may indeed be just the right description, because throughout all of this, staff might also feel at risk – meaning they need constant communication too.

But if there’s one piece of advice everyone agrees on, it’s this: plan ahead. Mr Gray says: “Those that prepare well will not only move their business on, they’ll do it when they want and get a 20-30 per cent higher price as well.” 

Find out how an exit strategy can help you manage the process of selling your business. For more information, visit http://www.fsb.org.uk/first-voice/topic/exit-strategy

Case study: Painful lessons


FSB member Bill Smith, founder of car servicing firm Church Road Garage, is already three years late in his plan of retiring by his 60th birthday, but it’s not from lack of trying. The Shrewsbury-based business, with an annual turnover of £500,000, doesn’t interest his children, and so has been put up for sale. 

The only problem is, it’s been on the market for more than a year, and so far, the experience has been what he calls “a total disaster”. “We’re a prosperous, well-regarded local business that has been going for 30 years, with seven to eight staff, but it just seems people aren’t willing to take on this sort of business, even though we can prove we’re profitable,” he says. 


He’s tried turning the business into a cooperative, owned by staff, but his mostly 20- to 30-year-old employees don’t have the money spare to buy in to the business. “I’m not desperate, but I’m 63 and I’m running out of options,” he says. He admits he probably didn’t broach the subject of whether his children might want a stake, or certainly not early enough, and has only recently turned into a limited company. 

“What I have done though is streamline procedures, and built the responsibility of my people so that I’m less personally involved,” he says. “I have no argument with the valuation, it’s just that it’s not moved as quickly as I thought it might.” 

Mr Smith is currently on his second broker, and if no one bites soon, this might force a change of plan. “If I can sell, I’ve said I’m happy to work a further transition period, but if I can’t I’m thinking of letting staff take on some form of profit share,” he says. “All options are now up for discussion.”