Owner Buy Outs as a Transfer of Ownership Mechanism in Family Business.

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1 Owner Buy Outs as a Transfer of Ownership Mechanism in Family Business. A guide for family business leaders. AUTHOR Simon Keane Interim Executive, Twiddle & Co. April 2014

2 Contents Owner Buy Outs as a Transfer of Ownership Mechanism in Family Business. 1. Overview 3 2. Determining the right course of action 3 3. First steps towards ownership transfer 4 4. The owner buyout process 5 5. Planning the OBO process 6 About Us 7 About the Author Simon Keane is a professional Finance Director and Company Secretary with a proven track record of increasing company profits and operational performance. Simon is a natural business leader with a flair for combining Financial Strategy with robust day-to-day Financial Management. He has considerable Mergers and Acquisitions experience both at the strategic and tactical level. Simon is widely regarded as a loyal and reliable business partner to established boards, family companies and growth SMEs. Simon is an Interim Executive at Twiddle & Co. who recently assisted in the ownership buyout process of a family owned business between its fifth and sixth generations. Following the transfer of ownership in his previous employer, Simon is now available for interim, project and consultancy assignments. For more information please contact Twiddle & Co / info@twiddleandco.com / Twiddle Twiddle && Co. Co. Twiddle Twiddle && Co. Co. is is a a trading trading name name of of Renovo Renovo Employment Employment Group Group Ltd. Ltd. Registered Registered in in England England && Wales: Wales:

3 1. Overview After running a successful family business for many years, inevitably many owners turn their thoughts towards how to pass it on to the next generation. Unfortunately, successful transition through such a transfer of ownership is not always a given, and the transition from second to third generation in particular can be notoriously challenging. Whilst owners may have many options over the exact mechanism of ownership transfer, this article looks at the particular use of Owner Buy Outs (OBO) by the next generation. 2. Determining the right course of action Clearly, an Owner Buy Out by the next generation can only occur if the next generation is willing and able to take over the mantle. If not, the alternatives may be a form of disposal or third party investment that would facilitate a final exit. However, assuming the next generation is already talking about how they will cope without you, what should you do? The answer, as in all things in life, depends upon circumstances. There are many questions that must be answered before a clear path emerges. Arguably the two most important questions are: #1 What do you wish to achieve financially from the succession? #2 Is the next generation ready to take control? Inevitably, the answers to these will generate a series of further questions. By considering the ultimate objective alongside an assessment of where you are in relation to achieving it, you will be better equipped to answer the questions before you and use that to form an opinion on the appropriate strategy and timescale. Many family businesses favour an ownership buyout in such circumstances because the financial responsibility ensures that new owners are actively engaged with the business and are ready to take the helm. On the other side of the coin, an ownership buyout may provide exiting owners from the previous generation sufficient pension provisions that aren t tied up within a business over which they no longer hold much control. OBO represents a very tax efficient mechanism for owners to exit their business with flexibility being afforded as to the structure of the consideration. Correctly structured, the exiting shareholders can get certainty through the HMRC clearance procedure. An OBO is proven to provide tax efficient incentivisation of the next generation whilst allowing the new Group to derive tax benefits in respect of debt introduced to the structure. Terry Jones, Lead Tax Partner (Yorkshire), BDO LLP Page 3

4 3. First steps towards ownership transfer Whilst all business owners will have an idea of the value of their organisation, this value is often highly subjective and tied to many different emotional strands. With this in mind, both generations must be able to stand back from the business and consider it objectively. Is it in the right shape for future growth? Are there new investments to be made that should be considered at the same time as succession? Could any unused assets be sold to generate cash for the sale? Naturally, the focus at this point should switch to the aspirations of the next generation, as it must be their vision that dictates the strategic objectives for the future. As well as this, discussing the future creates a clear sense of purpose, identifies any previously hidden opportunities and, hopefully, allows both generations to share in that vision for the future. A clear ownership transfer strategy must recognise all aspects of the succession, particularly the roles and responsibilities of both generations before and after the transfer of control. Will the exit be completed in one step, or will it be phased, perhaps with a minority shareholding retained? If it is to be phased, what are the phases and what is the timescale? Often, ownership transfer discussions begin years in advance of a concrete strategy. Many may find that the sheer scale of such decisions finally coming to fruition can be distracting, and the time investment required to meet different professional advisors can introduce additional pressure to ensure the business remains on track. With that in mind, many begin the ownership transfer process by introducing an interim manager to remain with the business while both current and next generations can look at the business strategically. Naturally, it is essential that such an individual is handpicked for the role through strategic placement; Twiddle & Co. can assist in the selection of such a high calibre individual. It is very important for the family to enlist the help of their professional advisors at any early stage in the OBO planning process so that they can provide input as to how the OBO should be structured and to ensure that the proposed scheme is workable. This will also reduce the risk of the scheme having to be restructured at a later stage to the possible frustration of certain family members who may feel that the goal posts are being moved as a result. Martin Whitehead, Corporate Law Specialist, Andrew Jackson Solicitors Page 4

5 4. The Owner Buyout Process Whilst it is possible to pass on ownership and control of a business in many different ways, including simple gifting of the company shares to the next generation or through inheritance, the Owner Buy Out method addresses many of the concerns that will inevitably arise. These may include the likely requirement to generate cash to fund retirement whilst keeping the business a family concern. Within this structure, the next generation effectively buys out the shareholding of the previous through the creation of a new holding company (Newco). Once formed by the acquiring shareholders, Newco buys the shares in the old family company in exchange for its own shares, debt (loan notes) and cash. The pre-requisite here is that the old business must be a trading company and not an investment company. The holders of not less than 5% of its voting shares, who have also been working directors for not less than one year, can then utilise Entrepreneur s Relief to provide an efficient exit from the business whilst reducing the burden of that exit to the next generation. A successful OBO will provide the answers to the key questions raised by all the parties involved, but should particularly address the following: How can the exiting owner(s) take cash from the business to assist with funding retirement? What options exist to reduce the burden to the next generation, e.g. partial funding through loan notes, which can be redeemed over time, rather than cash? Would loan notes assist the exiting owner(s) in providing a fixed income over time? How should the management of the business be structured after the OBO? What role shall the exiting generation play in the future business, bearing in mind that although control must have passed to the next generation, there may be a significant, albeit minority, shareholding in Newco? How will each generation react to the challenges faced by Newco post acquisition? If the passing of control is assisted by a single triggering event rather than a gradual handover, how will the inevitable risks of conflict and inconsistency be handled? Finally, there will almost certainly be other parties observing from the sidelines, e.g. employees, customers, suppliers and, not least, competitors. All of these will likely see an OBO as a definitive handover rather than a never-ending apprenticeship. What public provisions will be made to ensure any trust in the business is maintained? Page 5

6 5. Planning the Owner Buyout Process If you are considering succession planning, take some time to consider the following points: Timing When do you wish to hand over? Is the next generation ready? Is the business ready? If not, how can it be restructured whilst retaining the option of an OBO? Vitally, are you ready to let go? Is it worth hiring an interim manager to keep the business on track whilst the necessary arrangements for transfer are made? Structure Control must pass to the new shareholders, so you cannot retain a voting majority of shares; however, you may seek some shareholder protections through a shareholders agreement. Your likely role post OBO is that of Non-Exec. How will you deal with your new position in a positive way that does not result in the next generation having to always look over their shoulders at you? The Deal The business has to be valued and the deal struck, which could be a combination of a minority shareholding in Newco, loan notes and cash. Is external finance required to fund the deal and if so, how can that be structured? Are there different share classes that may complicate both the company valuation and the ratio of shares, loan notes and cash to be given in exchange? Post Deal Communicate You are stepping back from active participation in the business. Plan an organised handover of your contacts, be they employees, customers, suppliers or advisors. Insist that issues brought to you for review are redirected to the appropriate individual in the new management structure. Do not be tempted to deal with them, as it will undermine the authority of the new owners Make sure you are there to support and encourage, but treat any hand holding as a very short term measure. The next generation will make mistakes, just as you may have, and allowing them the freedom to do so can be a challenging process. Make the most of your Non-Executive position to add knowledge and experience to debate in the Company Board, but recognise and reaffirm the fact that it is no longer your decision. Enjoy your retirement! Page 6

7 Strategic HR Leadership Development Executive Search Tomorrow s Talent Today ABOUT TWIDDLE & CO CONTACT US info@twiddleandco.com Twiddle & Co. is a firm of talent management specialists serving the Private and Family Business sector. Our expertise lies in the attraction, development and retention of those people who will have a direct input and impact on your bottom line, as well as on your short, medium and long-term growth strategy. We understand the dynamics inherent in ambitious, growth-orientated Private and Family businesses, as well as the positive impact that getting the people side of your business right can have on sales, productivity, employee morale and customer relations. Through our Strategic HR, Leadership Development and Executive Search services, we can maximise your opportunity for growth by enabling you to attract, develop and retain the talent you need to ensure the sustainability and development of your business for years to come. Page 7