Passing the torch to the next generation of your business

Published:  03 July, 2018

Adam Bernstein looks at what to consider when deciding upon a succession plan for your business.

It’s not hard to find links for family-run heating and plumbing firms, as a simple search of the web will show. Importantly, as time progresses, the owners of these businesses will want to retire. The question is – who will take over?

According to the Institute for Family Business (IFB), two-thirds – 4.7m in total – of UK businesses are family-owned. Crucially, the IFB believes that around 100,000 of these firms change hands each year for a number of reasons – retirement, insolvency, or death.

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.”

Relationships can exacerbate the problem. Nick Smith, a family business consultant with the Family Business Consultancy, says families need think about relationship dynamics: “Will my children want to take the business over? Are they capable of running it? 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?”

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.

There are two fundamental issues for David. Does the current generation want to retire, if so, then when, and on what terms? Conversely, does the next generation want to take the business on, and if so, when, and what are their terms? However, 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.”

Interestingly, 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 one, 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, on the one hand, creating opportunities for the next generation, and on the other, generating inappropriate expectations on family members who, in reality, are neither suited for or motivated towards life in the family business.

If the decision to sell has been taken, David says the family should take advice on the options. 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.”

Businesses will generally be 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 says there are a raft of approaches and solutions including discounted prices and stage payments. He added: “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? “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,” said David.

But that, he says, may not be possible, and there may be many good reasons why the retiring shareholders keep an equity stake or 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.

Both Nick and David consider tax planning key. Nick says 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.

Family businesses are peculiar entities, caught 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 family business, one thing is certain – everyone needs to keep the lines of communication open.