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Succeed with succession

Adam Bernstein considers some of the factors to consider when owners of a family business plan to hand over to the next generation.

There are many family-run hire firms. Importantly, as time progresses, their owners will want to retire. The question for many is: who will take over? According to the Institute for Family Business (IFB) two-thirds, or 4.7m in total, of UK businesses are family-owned, and approximately 100,000 of them change hands each year for a number of reasons, such as retirement, insolvency or death.

David Emanuel, partner at law firm VWV and head of its Family Business team, considers succession issues to be an 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 consultant with the Family Business Consultancy, says families must think about relationship dynamics, such as, “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?”

An exit plan

Every business needs a succession or exit plan. In the case of a growing operation, family or not, there will also come a point when the owners need external talent to maintain growth. David Emanuel identifies two fundamental issues. Does the current generation want to retire, 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? Similarly, Nick Smith wonders about an inability of the senior generation to let go of the reins “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.”

Additionally, he sees a tricky balance to be struck between creating opportunities for the next generation, and raising inappropriate expectations in family members who are neither suited for, nor motivated towards, life in the business. If the decision is taken to


sell, David Emanuel says the family should take advice carefully. “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.”

Seeking a valuation

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 Smith says, “There are 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.”

The IFB offers advice on how the transition to the next generations can be managed.

However, 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,” says David Emanuel. Nevertheless, there may be

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 necessary.

Tax planning is also key. For Nick Smith, “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 so that most family firms 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 business means handing over a working lifetime of misery and a failing operation.

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