Leave the family firm in good hands

1 March 2005

Paul Clapham sets out the options for UK family businesses when the owners retire

Three family businesses in my small home town have stopped trading due to retirement in the past 18months. As a result, fifty people lost their jobs.

Yet each business was respected and long established, one had been trading for 40 years, one for 50 years and the third for nearly 100 years. I find it hard to believe that there was no interest in buying all that goodwill and taking the businesses on to the next stage.

Deciding what to do with a family business when the present owners retire can be a complex problem.

It may not seem urgent when retirement is a distant event. But failure to think about it and plan ahead could mean losing out financially. The business may end up being sold far below its potential value. In the worst cases, it could simply cease trading when the owner retires, with stock, plant and premises sold off. What a waste of all those years’ effort, building the business’s profitability and goodwill.

The classic succession route is to pass the business on to family. But even this needs careful thought. Will the prospective successors be able to carry on? Do they, or will they, have the same skills? Do they need those skills or would other abilities help to improve business?

Importantly, they may not want to take over.

The next choice is the natural successor from within the company, the person who has been trained to take over. If you employ such a person this can be ideal, but these stars are just as likely to go off and become competitors as stay around waiting for their succession. Even if you have a likely successor, it’s still necessary to plan, when, how and what they will have to invest. (And they may not like the answers to those questions.)

Most owners have no idea what the business is worth. The market in private businesses is not highly visible. Even drawing a comparison with another company in the same field from a business transfer agent’s website is only a rough guide. Premises, plant, manpower, location and customer base could all have a big effect on price. There are several ways to estimate the figure, the classic being a multiplier of profits.

Option one for those looking to sell is to use a business transfer agent. There are 386 members of the business transfer section of the National Association of Estate Agents. Since this is an unlicensed field, choosing a member of the NAEA makes sense.

The advantage of this method is that it seems straightforward. You sell to the highest bidder, and the process is organised by a specialist, much like selling a house via an estate agent. The service includes a free, expert valuation; advice on the dos and don’ts, the status of the market in your sector and an idea of timescale – not less than eight weeks but sometimes as long as 12 months. Commission charges and other costs vary. The norm is 5%. Additionally, advertising and market costs may be involved.

Solicitor’s fees will be another cost. It could be worth considering a specialist in business transfer, rather than the family or business one.

There are problems as well. This process demands discretion. You have to be secretive about your plans when dealing with staff, customers and suppliers, normally not wise management.

Inside view

Prospective buyers need to see the books at some stage, giving them inside information they could use if you don’t agree a sale.

If the business is sold on the open market, the buyer’s ability to pay is the main criterion.

But the business owner may have other concerns. They may have spent 30 years or more building the business, and want to be sure that standards will be maintained, especially if the name carries on. Will customers still have the best service? Will the staff be treated fairly?

In many ways a management buyout becomes an attractive choice. All the concerns about standards are dealt with. It offers continuity for staff, customers and suppliers. Timing is flexible and a MBO can often inject fresh energy into a business.

A management buy-in (MBI) is just as relevant. An existing team that has worked in the business sector but wants control could offer a satisfactory succession. The business’s accountants, especially the larger firms, can help generate interest in this type of deal.

However, bankers regard this as less secure than an MBO because the team is an unknown quantity.

The disadvantage of either an MBO or MBI is that although the owner can initiate the idea a successful buy-out is driven by the buyers, rather than the owner.

Many of these deals falter before completion because the buying team lacks commitment. Equally, the potential in-house team may lack the necessary breadth of skills or the entrepreneurial spirit to run a business. The process can take up to two years and is complex.

The biggest problem though is finance. It is unlikely that the management team could collectively afford to buy the business without incurring debt. Commonly, gearing will be 5:1 or as much as 10:1.

Full funding normally requires the involvement of a venture capitalist. This weight of debt and the need to ratchet up returns to service it, can prove a disadvantage. It is common for MBOs to sell on after a short period (inside 6 years), not least because external investors demand it so they can realise a gain.

The need for heavy borrowing and its undesirable consequences can be lessened if owners allow the assets to be bought over a period of time, rather than all at once.

A further option to consider is an MEBO, a management led all-employee buyout. Essentially this is a means to sell the company to its existing employees. The St Andrews based Baxi Partnership specialises in this approach and says it’s the only one which is an all-round winner.

The right conditions

But this is not an option for everyone. Baxi’s criteria are: a strong business with consistent profits and low debt; at least 40 employees and preferably over 70; plus a good continuing management team. The company also encourages the vendor to keep a sizeable share (up to 25%) and stay on, usually as a non-executive chairman.

For the business owner who can meet these conditions there are serious advantages. Everyone’s on the same side. As a result, it’s quick – from first meeting to completion in two to three months. It allows a company to continue to grow, long-term and all the staff benefit financially. This leads to sustained, higher productivity.

The seller gets a fair price and feels satisfied that the deal has helped staff and community as well as himself. MEBOs attract good public relations, raising the value of the business further.

A further option is to keep an eye on the trade press. The demand may not be huge, but you will see advertisements from principals or their agents looking to buy businesses.

The same applies to more general publications like Dalton’s Weekly.

Banks, accountant and solicitors stress the importance of planning ahead. Since the sale process is extended, owners should have their sale built into a forward business plan. Without careful preparations, the business will sell for less than its potential value.

Tidy the business financially. Get the books in order. They should be complete, up to date and present picture of robust good health with no surprises to come.

So give more attention to cash-flow, in particular tighten up on debtors. A customer base which pays on time is a big selling point. Long-term debtors should be addressed too. Be nice, negotiate part settlement, apply for county court judgements, write them off. Whichever route you take, you want them off your books.

Increased income and reduced costs will enhance value. Progressively cut down on discretionary expenditure: travel, entertainment, vehicles, office equipment to cut down on end-of-year profits, but be careful that you don’t send the wrong message to customers in doing so.

Similarly look at essential expenditure – would switching utility providers cut costs?

Spend time on your customer database. Update the detail, communicate with them regularly and feature sales/enquiries/future call-back dates. This is a simple way to demonstrate to a prospective buyer the base value of repeat purchase in the business.

Build the succession or sale of your business into you plans, or you might be left with a result that will mar the next stage of your life.

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