The latest Argos Mid-Market Index which shows movements in private company prices has just been published. It shows data up to Q3 2017 and indicates a record high of 9.5x.  As you can see from the graph it has been steadily climbing since 2009.   So if you're a business owner it's a good time to think about exit.  Or at any rate to make sure you have a credible exit or succession plan in place.   Many owners of private companies have much of their wealth locked up in their shareholding and so even an equity release transaction - perhaps by selling shares to a third party like a private equity house can help balance their personal portfolio.

The other factor I now start to hear in conversation with business owners is concern about the tax regime that a new government might bring.    The capital taxes regime re the sale of company shares is particularly benign with Entrepreneurs' Relief effectively reducing the rate to 10% on the first £10M of lifetime gains.  Whilst Entrepreneurs' Relief was brought in by a Labour government there is an up swell of concern that a Corbyn led government might change things.

None of this may happen of course but it does underscore the need for every business owner to have a plan for exit and succession - even if it is explicitly not intended to happen for some time.

We're running our Business Exit Strategies Seminar in Stevenage on 23 November the day after the Chancellor Philip Hammond's budget speech.  So we should have clarity at least on his short term tax plans.

Our event, which is free, gives useful insights into a range of topics:-

• The current M&A market
• Strategic planning
• How to build value in your business
• Business valuation
• How to achieve succession through a management buyout
• Tax - how to mitigate and also how to use your tax affairs to build value in your company
• Company sales - how to sell your business, pitfalls, why some companies don't sell

There are a few places still available - and the venue (Novotel just off the A1M) is easy to get to from Hertfordshire, Bedfordshire, Northamptonshire, Cambridgeshire, Essex and North London.  So have a look at our website for the full program and booking.  http://www.pem.co.uk/corporate-finance/business-exit-strategies-stevenage

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Buyout at Molecular Dimensions

Planning for exit and succession can be difficult in any business, but in family businesses there are additional factors to consider.   One of the problems with family succession planning is that the two key objectives – liquidity and preservation of the business legacy appear to be in conflict – how can you get cash without selling up?   A sale to a trade buyer may be unattractive if the plan is to keep things in the family, and this is where the idea of a sale to family comes in.  

This is a form of management buyout – the family members buying the business are very often the team running the company.    Often it goes beyond that to key managers – hence the occasionally used abbreviation the FAMBO. This is meant to mean Family and Management Buyout, or Family Buyout, although just to confuse things I’ve recently seen it used in East Anglia to refer to a Franchisee and Management Buyout.   It can also be called a VIMBO or Vendor Initiated Management Buyout – because the its usually (though not always) the older generation which initiates the sale to the younger family members.  At PEM we prefer to refer to such deals as Succession Buyouts – because that neatly encapsulates the overarching strategic intent of the deal.

Because family relationships are involved things can go wrong so as to delay the transaction or even kill it completely.  So here are some key thoughts on how to preserve family harmony whilst successfully completing a buyout.

Plan ahead and don’t rush each other. It is really important that harmony and trust is maintained. Nothing breeds suspicion more than the idea that one family member wants to take advantage of another, either by being pushy or appearing to scheme behind the scenes. This is true whether a family member is a buying or selling. An aggressive buyer almost ensures that the seller will react negatively; an aggressive seller communicates desperation and may undermine his or her own negotiating position.   Actually this is also true of Succession Buyouts amongst long standing colleagues who are not related.

Take account of peoples personalities Families ought to know one another pretty well. They know about personality traits or past circumstances giving rise to unusual levels of loyalty, or even resentment, or jealousy.   This might all come out in the run up to a transaction, sometimes they are deep-seated psychological feelings, and can be almost childlike—“Dad always preferred you.”   Being alert to such attitudes and steering the transaction in a sensitive way that respects feelings will help ensure success. Often the most important thing is to make sure everyone is listened to.

Get the business professionally valued If your shareholder agreement doesn’t prescribe a valuation methodology, it will be helpful to everyone involved in negotiating a transaction that there should be an independent assessment of valuation. Fairness is the key to completing the transaction and maintaining positive family relationships, and possibly sanity.  Neither buyer nor seller wants to looking back on the transaction with regret or suspicion.

Find some trusted advisors. Truly independent advisors who have the best interests of the family in mind can be hugely helpful in communications and facilitating agreement amongst the family. Each family member can get some independent advice, but its much better to select an adviser with a track record of brokering/facilitating such deals amongst close knit family or business groups to work for the company/family as a whole with the objective of reaching an agreement that works for all.  A skilled adviser will listen to all the agenda’s and try to manage any emotional pressures that arise during negotiations.

Tax and estate planning My tax colleagues would point out that it’s really important to consider the tax and financial affairs of the whole family, up and down the generations. And a deal like this is an opportunity to consider these things holistically.   Has the family provided for everyone as they intend and have they done inheritance tax planning?  Again these are things that need to be done early. One of the consequences of some buyout structures is that IHT planning becomes more important – don’t leave it to the last.

Family businesses are important to us all – according to INSEAD they account for 57% of US GDP.   There’s a general perception that many don’t make it beyond one or two generations. I’m not sure that’s true, INSEAD reckon there are 5,500 bicentenary family businesses around the world, and we’ve certainly worked with some family businesses which are now at fourth or fifth generation stage.  Visit our website to read about some of the family buyouts we've worked on.

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EXIT STRATEGIES FOR FAMILY FIRMS

We’re often asked how to achieve succession within family businesses.  For this type of business Business Exit Strategies mean how to pass it on and not how to achieve a trade sale of the company.  Very often this will be done in the form of a Vendor Initiated management buyout, particularly if those who are to succeed are not just family members.   The VIMBO or succession buyout structure can also work well in a family deal, if Mum and Dad want full value rather than gifting the business, and if they need some sort of carried interest or ongoing income.

SIMPLEST CAN BE BEST

That said simple is often best.   And particularly in small deals variations on the share buyback theme can be useful. 

SHARE BUYBACK

We recently helped a family business in Suffolk achieve succession using this type of structure.   It wasn’t a huge business, but was sustainedly profitable, and had grown to have branches in Essex, Norfolk and Cambridgeshire.   Mum and Dad had been running their business as a company for many years, but had involved their two sons in the business as full time directors.  As the sons took more responsibility in the business they felt that it was time for them to take control.  The aim was to achieve the transfer and for the parents to have the profits which had accumulated in the company to be paid out to them tax efficiently.    If the arithmetic stacks up this can be done using a buyback of shares.  

The tax legislation which gives favourable tax treatment to an individual when a company purchases some of its own shares provided certain hoops are jumped through.   In outline the steps are:

• The sons get given some shares (a 32% minority holding) in the company a few years before Mum and Dad were ready to fully hand over the reins.  Result = no tax charge for parents or children due to the availability of tax reliefs - it qualified as a trading company.
• More recently, when Mum and Dad decided to retire, the company bought back their shares.  This was done     correctly and so the proceeds will be taxed as capital receipts for the sale of their shares (and not subject to income tax).  Entrepreneurs’ Relief should be available as both the individuals and the company meet the conditions and so the tax charge is only 10%.
• The company then cancelled the shares so that the shares held by the next generation are the only shares in issue and they all of the company.

THE GROUND RULES

In all deals there are some company law rules to be observed, or the danger is that the purchase of shares is an invalid purchase with unfortunate consequences.  As ever there are also tax rules to follow – and they’re often not quite so clear cut.   In this case the two keys matters that had to be established were that the company was a trading company for the purposes of Entrepreneurs’ Relief and that the purchase of shares is for ‘bona fide commercial reasons’.  The ability to “clear” this with the revenue in advance is helpful.   Of course there is usually a financing issue too.  In this case the company had the cash to payout. But what if the company doesn’t have enough cash?    There are ways round this – and indeed this might be a cue to consider a Newco buyout structure.

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Many business owners believe the act of selling their business is similar to passing the baton in a 400 metre relay: once you’re finished running, you get to relax.  In reality, buyers will insist that you stay on for a transition period – anywhere from six months to five years – during which time you continue to work in your business to help the buyer capitalise on the investment they’re making.

THE Question 

At some point in the process of selling your business, a prospective buyer will ask you – usually quite casually – “Why do you want to sell your business?” These eight seemingly innocuous words have derailed more deals than any others.    As advisers we often get asked this one about businesses we are selling, but you can be sure that the buyer will look you in the eye and ask it when you get to meet them.

Buyers ask THE question to evaluate how likely and willing you are to stay on or if you already have one foot out the door.

Obviously you don’t want to lie, but there is a right and wrong way to answer THE question. Answers like “I want to slow down a bit” or “I want to travel” or “we’ve got a baby on the way and I want to spend more time at home” communicate to a potential buyer that you plan on winding down when they take over. However, what they want to hear is your intention to help them realise the potential locked inside your business.

Here are some suggested responses based on your age.

If you’re under 40, you clearly aren’t ready to “retire” so you need to communicate that you see an upside in merging your business with theirs:  “In order for us to get to the next level, we
need to find a partner with more <insert sales people, distribution, geographic reach, capital or whatever the partner brings to the table>.”

If you’re between 40-55 years old, most people will understand the need to shore up your personal balance sheet:   “I’ve reached a time in my life where I want to create some liquidity from the value I’ve created so far, and at the same time I want to find a partner who can help us get to the next level.”

If you’re over 55, you can start to talk about retirement, but you want to make sure you communicate that you still have lots of energy and passion for your business.  “I’m at a stage where I need to start thinking about retirement. It’s a long way off yet, but I want to be proactive.”

Rehearse your answer to THE question so it becomes a natural response when you are inevitably asked THE question by a potential buyer.   Your honest, if rehearsed, answer delivered face to face will be powerful and convincing.

According to Imperial College London 95% of business owners have no exit or succession plan. Sounds a bit high to me, but I guess if the question was asked about written planning then it may well ring true.

We're interested to better understand how business owners in our region think about these issues - and so we're conducting a survey. It is difficult for even the most successful business owners to grapple with exit planning. The survey is to test the extent that directors and shareholders are ready to achieve the kind of exit that they'd chose, and at a time of their choosing - or if they will simply be forced to respond to events? Of course having a plan should allow them to maximise the value of their investment in the company, and exit in a manner of their choosing - whether this be a management buyout or a company sale.

As an economy we need successful entrepreneurs - and they need an orderly way to realise the wealth that lies tied up withing their businesses. If you'd like to do the survey click here - as an incentive there's a draw for a bottle of champagne or a free valuation report.

The Six Biggest Fallacies about Succession Planning

I meet lots of business people who want to talk about putting in place an Exit Strategy, and planning for this as well as grooming their companies for value growth prior to exit.   Surprisingly its less common to find folk prepared to talk about succession.  

Why don’t people like to talk about succession – here’s some understandable reasons.

• Its not a crisis yet so let’s defer it.
• I don’t have a suitable successor – so I don’t feel I can retire
• I don’t have any obvious and outstandingly good candidates – how can I chose – better to wait until I find a suitable candidate
• How do I get paid out?
• It’s the wrong time to sell – so I’ll wait till things improve

But its important – like death and taxes the need for succession won’t go away.   So here are some things not to do – or the six biggest fallacies about succession planning.   Listen carefully – you may here some of these in the corridors of your company.

 “What this place needs is more people like me” –  Leaders who hire or promote in their own self-image run the risk of creating a band of “Mini-me’s” rather than a well-balanced team in which the challenges of one member are balanced by the strengths of another.  Good leaders surround themselves with individuals who have complementary skills and strengths.

“What this place needs is new blood” – Bringing in new people may “shake things up” but it can also de-motivate the individuals who have been contributing for years by robbing them of their opportunity to shine.  Before adding “new blood” to the team, assess the skills and potential of existing employees – the company’s next CEO may be languishing in another role.

“Managing ‘things’ qualifies you to manage people” – Promoting the best functional specialists without assessing and strengthening their management skills can be a recipe for disaster.  Make sure you have a process to identify which of these performers have the potential to be effective people managers.

“Let’s keep this to ourselves” – Identifying high potential candidates for future leadership roles is the first step, but not letting them know about it is a mistake.   You run the risk of losing top performers to a competitive job market, but you also miss a valuable opportunity for development.

“Everyone wants to be a senior exec” – Not all managers want to face the stress of a leadership role. But these same managers can be a big asset to an organization.

“Blood is thicker than water” – Just because a son or daughter is in line to take over the family business doesn’t mean they’re qualified to be an effective leader. Call it the third generation curse but only 24% of UK Family Businesses survive as such through to the second generation and only 14% make it beyond the third generation.

So start planning now, whether your business exit options are through a trade sale, or through a management buyout, you will need to have a plan for succession in management as well as succession of ownership.    To address these issues we are running an updated version of our Business Exit Strategies Seminars.    They will also cover tax mitigation, management buyouts, grooming, and selling  your business.   The events are practically focused with interactive sessions, and are aimed squarely at business owners.   This time around we are holding them in Hemel Hempstead, Milton Keynes and Brentwood.  Have a look at our events page for more details.

With acknowledgment to John Szold of www.planningforsuccession.com