Planning early for succession
Other than the bigger UK and international businesses, there are few Guernsey businesses that have been around for more than one or two generations. Some businesses fail because their products or services are no longer needed or because they have suffered some calamity. But there are many which just fade away because their owners have failed to do any proper succession planning.
Before the arrival of our thriving finance industry when there were fewer employment opportunities, businesses often passed between generations in the same family, These days, sons and daughters are not expected to follow their parents into the family business, and rarely do, so succession must come from outside.
Ironically, it is often the most successful businesses that are the hardest to sell because they are the least affordable: high profitability means high goodwill value, not to mention high asset values if these businesses operate from their own premises.
A business is sometimes bought by a third party, and sometimes by a key employee or employees, which is known as a management buy-out or “MBO”.
At Collenette Jones, we help many clients plan to sell their businesses. This must be done early, sometimes many years in advance of an exit. If the business is to be sold externally, the owner must begin to distance himself, popping a ‘humility pill’ and understanding that he cannot be seen as integral to the future success of the business. This will mean cutting back his hours, taking proper extended holidays and employing a good manager. It may mean improving the brand so that customers identify with the business and not the owner. If the buyer needs bank or other finance, the lender will be looking at all these sorts of issues.
If the business is to be sold internally, the owner must plan early to identify or recruit an employee or team who (i) have the technical abilities, and (ii) have the entrepreneurial skills, desire, responsibility and often bravery to buy into the business. In my experience, these personal qualities are far rarer than the technical qualities, and are usually nothing to do with the education or background of the employee(s).
There are a number of ways of selling a business to an employee and achieving proper value. If the business is run as a sole trader or partnership, it first needs to incorporate. Many successful MBO’s involve the employee being gifted the first tranche of shares (typically 5%) on the understanding that he will acquire a substantial additional chunk of equity at market value shortly after. For the arrangement to work, the employee must take on the risk of doing this by using his hard-earned savings or getting a bank loan. This buys commitment to the buy-in process – ‘putting your money where your mouth is’. There must be some pain.
We usually recommend a shareholders’ agreement with a clear dividend policy to enable bank loans to be repaid and to provide funds to buy more shares. Share options enable a buy-in at a fixed price or the share price can be calculated using a floating valuation method. After a period has elapsed (usually 5 – 10 years), the exiting owner will offer the employee the balance of his shares to complete the buy-out, by which time he will have substantially reduced his hours and responsibilities.
By then, the evidence of ongoing profitability should enable the employee to get the finance needed to complete the buy-out. Often the loan can be from the exiting owner, who has been reassured over time that the employee has the required competencies to generate the profits to repay the loan.
Both internal and external business sales take time to work effectively, and, as a very successful client said to me recently, “the first thing that you should do when you get your feet under the desk as a new owner is to plan who is going to take your place”.