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Ensuring the best succession planning for your business

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For successful company owners who are thinking of business succession, the options are many and varied, and no single solution is right for everyone. With our many years of experience in business law, we’ve seen many companies pass hands – some more smoothly than others. That’s why we’re giving an overview of the potential succession planning routes for any business owner.

Options for business succession planning

Listing on the Stock Market
Sale to a third party
Family dynastic succession
Management buy-out
Employee trust buy-out
Winding-up or solvent reduction of share capital

We will discuss each of these options in more detail below.

There are many issues you should consider when deciding what method of business succession is right for you. Main factors affecting your decision may include:

Whether your business is in a burgeoning sector with growth opportunities
Level of sustainable ongoing profits
Quality and experience of management or younger family generation
Tax impact on sellers
Risk/return on any deferred consideration
Post-completion liability of seller for warranties and/or indemnities (including tax)
Ongoing involvement of sellers in post-sale business
Philanthropy – wanting to preserve the security of the business and its employees

Stock market listing

If your business is either:

At the forefront of a promising new business sector with significant growth opportunities; or
Is well established in a secure business sector with significant and growing net profits

then a stock market listing may be an option.

There are significant regulatory requirements, professional advisers required (with comparably high overall fees), tax implications and timing issues. However, the ultimate rewards, opportunities and risk controls may make this a preferred choice for those few private companies that fall within this scope.

Third party/market sales

If you are considering selling to a third party in your succession planning, the most important thing to understand is that timing is everything.

A former client, for example, sold his mortgage broking business for £44 million – and a year later the market had changed so drastically that the same business was rendered worthless. This demonstrates that market developments and perceived opportunities are key factors in assessing the best time to sell.

A sale to a third party needs a lot of planning – including preparing the business for sale, assessing options, reducing risks, tax planning, setting payment terms, and so forth. It is important not to underestimate the complexities involved in continuing to run the business whilst controlling the quality and confidentiality of information required by a buyer and its advisers.

The general advice to business owners contemplating a future sale to a third party is to start planning two or three years in advance. If you can time events so that you entertain offers when you don’t need to sell, then you will have more leverage over the sale negotiations and will not be as stressed.

Issues that will need to be resolved in any third-party sale negotiation include:

Confidentiality of information provided to a buyer – a non-disclosure agreement (NDA) is recommended
The potential time intrusion on employees and/or the business required by a buyer or its funders
The period and extent of post-sale risk arising from warranties and/or indemnities
Time, responsibility or control issues required by sellers to support transition of continuing business
How any restrictive covenants required by the buyer may impact post-sale plans of the seller
Tax impact on sellers

A major benefit from a third-party sale is that the vast majority of sellers of shares in private companies will benefit from Entrepreneurs Relief on any capital gains made. That means their tax liability will be only 10% of the balance of gains made after personal allowances. It is one of the most efficient methods of extracting net-of-tax value from the business.

good succession planning will help you make the deal this is right for you

Family dynastic succession

Family dynastic succession involves passing the business down to the next generation. The statistics for ultimate success for such dynastic succession are not good; scenarios are common in which the first generation passes the business to children who are immune to the struggles of establishing businesses and the risks involved, drastically reducing the business’ value as a result.

Business owners who want to pass their business to their children are well advised to arrange for them to gain work experience in other independent businesses. That way, they may learn more essential management skills – business risks and opportunities, finance and workforce interaction – than they would if they stayed within the protective shadow of the family business.

If the current owners want to establish a longer-term family legacy through succession planning, they could establish a family trust to own the shares; this way, each successive generation would be stewards of the business rather than being granted sole responsibility.

If the original owners wish to retain some input into the buying vehicle, documents outlining the future governance structure (the shareholders agreement and articles of association) will also need to be carefully drafted during succession planning to cover the relevant issues.

Tax planning will need careful consideration, which is a subject deep enough to merit separate discussion. We would be happy to discuss tax planning with you personally; contact our Corporate department to arrange an initial ‘no fee’ discussion.

Management buy-outs (MBOs)

MBOs are a common succession planning method for owners wishing to sell their business; they essentially involve the current owners encouraging an existing senior employee team to acquire ownership of the founding owner’s shareholdings.

Benefits

An MBO has the benefits of

retaining confidentiality (as details of the business are kept in-house);
maintaining legacy for the original founders – who maintain a historic link with the ongoing business through the employees they sold to;
providing continuity for customers, suppliers and third-party funders and
avoids the disruption/impact on morale when new, third-party buyers seek to impose new systems/methods of trading onto long-established practices.

An additional significant benefit for a selling shareholder is that they are not liable for any breach of warranty where that breach was already known to any of the acquiring management team.

Disadvantages

One disadvantage to MBOs are that in most cases the sale price must be supported by the sellers agreeing to receive a material proportion of that price on a deferred basis. That then raises questions over the reliability of receiving that deferred payment, such as:

What security may be required?
What interest rate should be paid?
What other default events should crystallise early repayment?
Should there be an anti-embarrassment clause?

Also, a share sale is a time-consuming activity. If the current owners are active directors in the business – and are negotiating with other senior employees and a supporting bank/funder – there is a real risk that focus on day-to-day trading activities may suffer as a result.

And finally, if owners start negotiations with senior employees and then fail to reach agreement, that may have a devastating impact on the morale and stability of those senior employees on whom the day-to-day business activities depend.

To summarise, whilst an MBO can be an effective method of transition for share ownership and business continuity, there are significant issues and risks that have to be considered carefully at the outset.

Employee trust buy-outs (ETBOs)

An ETBO is similar to an MBO but involves all the workforce effectively owning a trust, which is established for their benefit to acquire the shares.

It is a tax-efficient method of share acquisition – but the problems in funding ETBOs in practice mean that these are not common. From a typical share seller’s perspective, the claim of a new, junior employee to benefit from an ETBO is less persuasive – so MBOs are usually preferred to ETBOs.

However, where all the factors meet the sellers’ needs – and there is sufficient experience in the senior employee team to guide the trust for all the employees’ benefit – a sale to an EBTO is tax-free for the seller. This in itself may be the decisive factor in the right circumstances.

Winding up/solvent reduction of share capital

The final option for owners wishing to realise the value of their shares is a winding-up. However, winding-up fees, and settlement of any existing business contractual liabilities, rarely make this an attractive option. Whilst the winding-up of the company may terminate risks for former directors, the liquidator also terminates any legacy – and the employees will need to find new employment.

Solvent reduction of share capital is also an option – but pre-supposes that:

The company has sufficient available distributable profits and cash to fund a share buy-back;
There will be at least one shareholder continuing to own shares
The pre-sale directors have sufficient information for them to swear a declaration of solvency – that the company will in the next following 12 months be able to pay all its debts as and when they arise.

So again, whilst both a winding-up or a solvent reduction of share capital are options to consider, the circumstances will be specific to that case for either to be the preferred method to realise the value of the business.

Enquire for an initial no-fee discussion about succession planning

Owners of growing and successful businesses should take time to consider the medium to long-term future of the business, and the available succession planning options to realise the value of their investments.

Suitable tax advice and tax planning may materially improve net receipts – so take advice early from the experts at Astle Paterson. Our Corporate team are happy to receive your enquiry. If you would like an initial ‘no fee’ discussion with our experienced solicitors, contact the team directly: