According to the Institute for Family Business (IFB), two thirds of UK businesses (4.7 million in total) are family owned. Of these, some 17,000 collectively generate over a quarter of the UK’s GDP and employ around 12.2 million people. Crucially, the IFB believes that around 100,000 of these firms change hands each year for one of several reasons – retirement, insolvency or death.
The world of veterinary medicine has its own succession stories. In October 2014, a nine-generation practice in Chipping Norton with 340 years of history came to a close when the then owner of the business, Adam Walker, retired and his two children chose not to take on the practice (The Telegraph, 2014). He didn’t want to pressure the children to become vets – one is now a teacher and the other works for a firm that sells licensed premises.
Difficult discussions
David Emanuel, partner at law firm VWV and head of its family business team, considers succession issues to be the elephant in the room: “Current and future generations often find it incredibly difficult to talk about succession, and can make assumptions about each other’s intentions which lead
Current and future generations often find it incredibly difficult to talk about succession, and can make assumptions about each other’s intentions which lead to misunderstandings and tension
to misunderstandings and tension.” He points to a recent PricewaterhouseCoopers (PwC) Family Business Annual Survey, which suggests that only 30 percent of family businesses make it to the second generation, 12 percent to the third, and just 3 percent a further generation (PwC, 2016).
Relationships can exacerbate the problem. Nick Smith, a family business consultant with the Family Business Consultancy, says relationship dynamics need to be considered: “Will my children want to take the business over? Are they capable of running a practice? Is there room for more than one child? Will they fight? How do I deal with ownership if some want to work in the business and others don’t?”
The main issues
Every business needs a succession or exit plan. In the case of a growing business, family or not, there will also come a point when the current owners need to hire external talent to maintain growth.
One solution is for the family to find time away from the business to discuss the future. Family members must know that meetings are convened on neutral territory and that they are expected to speak their minds freely and honestly.
There are two fundamental issues for David: Does the current generation want to retire? If so, when, and on what terms? And does the next generation want to take the business on? If so, when, and on what terms?
Nick wonders about an inability of the senior generation to let go of the reins of the business – “this can be for a variety of reasons including a lack of faith in their successor, a belief that only they can steer the business forward or a fear of what life after the family business holds”.
Starting the process
David sees many established family businesses wanting the next generation to forge careers of their own: “The decision to join the family business should be a conscious decision, rather than a sense of obligation, and it should bring with it the skills and experience learned elsewhere.”
For Nick, there is a tricky balance to be struck between creating opportunities for the next generation and generating inappropriate expectations. In some cases, family members who are neither suited for nor motivated toward life in the family business could find that they spend their working life in the family firm.
If family members aren’t committed to the future, the best answer is likely to be to sell up. David says that advice on value and likely exit options from an experienced corporate finance adviser is necessary. Nick thinks that families often choose to sell to a buyer who they believe is most likely to preserve the culture and ethos of the family business.
Sale and no pass-down
Once the sale decision has been taken, David suggests that the family should take advice on the options. He advises seeking recommendations but notes that the advisers engaged will be dictated by the size and complexity of the business. Further, he says to “think hard about engaging people who work principally on a success fee percentage commission-only basis – the overall cost may be higher, although you may be insulating yourself from costs if a deal doesn’t go ahead – but there can be a conflict of interest for people remunerated only if a deal goes ahead”.
One way to ease the process is to undertake some financial and legal due diligence as if the seller were a buyer, to identify any gaps or issues that may affect price or saleability. Internal due diligence also means the firm is prepared for what the buyer’s lawyers will be asking for in due course.
Seeking a valuation
Businesses are generally valued on one of three bases – the value of net assets plus a valuation of goodwill; a multiple of earnings; or discounted future cash flow. Nick sees some families seeking the next generation pay the full market value for their interest, and other situations where shares are just given.
“In between the extremes,” says Nick, “there is a raft of approaches and solutions including discounted prices and stage payments. There are also more complicated solutions such as freezer share mechanisms, where no sale takes place but the senior generation lock in the current value of their shares to be left to the wider family and the next generation family members actually working in the business receive the benefit of any growth in value during their time in charge.”
But what of an arm’s length sale? In this situation, David says, “The family will ideally want to be paid in cash, in full, at completion, rather than risk the possibility of deferred consideration not getting paid because the business gets into difficulties under its new owners, or a dispute arises over what should be paid.” But that, he says, may not be possible, and there may be many good reasons why the retiring shareholders keep an equity stake, agree to be paid over time or agree that some of what they get paid is subject to future performance. Even so, he suggests starting with the idea of the “clean break” and working back from there if you have to.
It’s important to remember that in a succession situation, where one generation is passing the business to the next, and the retirees are expecting a payment of value to cover their retirement ambitions, deferred payment risks may be looked at differently depending on the circumstances – families will be more trusting.
Tax planning
As might be expected, tax planning is important and should always form part of the decision-making process, but should never be the main driver. That said, no one wants to hand over, by way of inheritance tax, 40 percent of the value of what they have worked for.
Both Nick and David consider tax planning key. Nick thinks that “the most important point is what is right for the family members and the business itself”. He believes the UK offers a fairly benign tax-planning environment for family business succession so that most family businesses can be passed on free of inheritance and capital gains tax to other family members. However, the risk of paying a bit of tax pales into insignificance if passing on the family business to the next generation means passing on a working lifetime of misery and a failing business.
David says it is important to remember that if Entrepreneur’s Relief is available, the effective rate of Capital Gains Tax is just 10 percent.
In summary
Family businesses are peculiar entities, riven by both the need to compete in the marketplace and the need to keep familial factions onside. Whatever course is taken to secure the future of the business, one thing is certain – everyone needs to keep the lines of communication open.
