Business succession…. think of the employee ownership option

It has been a tough few years for Welsh businesses and their owners....

It has been a tough few years for Welsh businesses and their owners. Short term plans were torn up and many owners and managers found that their strategies for expansion and other changes were put on an indefinite hold. One such decision facing business owners, that may well have been put on the back burner, is the sale of their business, a possible retirement or the start of an exciting new business venture.

The pandemic has highlighted the stresses placed on small businesses and their decision makers. We know of the business owner being caught up in the daily pressures of running their company; the staffing issues, supply chain problems, let alone customer demand or the lack of. The old phase ‘working in the business not on it’, has rung true, notably with the impact of Covid restrictions.  At this time, for many owners, stepping away from their business may have been the furthest thing from their minds. However, failing to plan ahead can cause uncertainty and disruption, and jeopardise the future of the business they spent many years of hard work building up.

Clearly Wales is not unique in this, but we do know that Wales is predominantly a mixture of micro and small businesses (indeed in 2019 it was at 99.4%)[1], and this does present its own challenges. Add to this the facts that we have an ageing business owner profile with many approaching retirement age; 29% of businesses have been owned by the same owner for more than 21 years, and Welsh small business owners tend to hold on to their firms for longer than the UK average, you can start to see why many SMEs in Wales face succession issues.   

[1] https://gov.wales/sites/default/files/statistics-and-research/2019-12/size-analysis-active-businesses-2019-503.pdf @StatisticsWales

Also consider that Welsh businesses tend to be locally rooted and support the economies and communities around them. Plans put on hold, whispers of a sale, and changes to market conditions can send ripples of uncertainly and apprehension through the towns and villages served by employers.  

Is 2022 the time to re-start the succession planning process? If so, preparations need to be made early and decisively.

So what are the exit options a business owner could consider?

  • Do nothing. This will just delay the inevitable and in an unforeseen circumstance could leave the business owner, their dependants, their employees and their customers and suppliers with many different problems to deal with. Uncertainty leads to performance and well-being issues and staff seeking out their own alternatives.
  • Transfer the business through family ownership. This is a positive approach to business succession, often offering business continuity. However, if there is no one within the family who is interested in taking over the business, or capable of taking over the business, it is a limited option. Just because they are family, doesn’t mean they will make good owners or managers.
  • Sell the assets of the business. This will recoup a limited amount of investment in the business but almost certainly won’t reflect the whole value of a successful business.
  • Trade sale. This is often the most common exit plan for business owners. However, it must be considered in the light of what will happen to the business and the employees after the sale and whether it is the best way to generate the true value of the business. What is the demand? What is the buyers’ intention? Will it protect the business owners’ legacy? Will the business actually remain in our community?
  • Management buy-out / buy-in. A management buy-out (and its variation a management buy-in, where external managers buy into the business) are strong options for succession. However, the process is dependent on the existence of a cohesive and effective management team and the management team’s ability to raise finance and offer personal guarantees where they are required.
  • Employee ownership. Employee ownership is a less understood approach that has some similarities to a management buy-out approach. Instead of a management buying out the business, the employees do it either directly or by means of setting up a trust to buy the business on their behalf. Examples of well-known employee-owned businesses include the John Lewis Partnership, Aardman Animation, Cwmni Da and Tregroes Waffles. Since 2014 when Employee Ownership Trust legislation was introduced providing owners and employees with tax incentives, there has been significant growth in the numbers of employee owned businesses in the UK and also in Wales.

Why Employee Ownership?

The succession option of selling the business to employees is a strong choice. Employee ownership as a model is as commercial a business deal as selling to another business or owner. It just has different mechanisms for transferring and financing that ownership and places more onus on employees to decide future direction.

Consider the SMEs mentioned previously; those businesses where the owner has built a hugely positive reputation as a business and within its community. Employees are proud to wear the badge and working for that company actually feels like something different and special. This could be maintained by an external sale, but putting the business in the hands of the employees can drive the business to even greater things. After all, success is often based on the skills, knowledge, training and loyalty of the employees; and who better then to protect the owners’ legacy and to evolve the brand further than employees themselves.

Employee ownership as a succession option means:

  • Minimal disruption for the business, particularly if advised by specialists who can support with governance, shares and what structures are needed.
  • No need to find a buyer. Employees will already understand the potential of your business and will pay a fair price.
  • Tax breaks that benefit both seller and employees. For example, if an Employee Ownership Trust is used, gains of up to £3,600 p.a. tax-free can be made as part of a profit sharing plan. If an owner or owners sell a majority shareholding to an EOT, this sale is free of Capital Gains Tax.
  • The owner is in a strong position to negotiate the exit terms and can fashion a model that suits both parties. The owner will also be able to negotiate the sale of the business at an agreed pace, and can agree upon what level of involvement in the business, if any, is to be maintained.
  • Jobs are safeguarded, relationships with contractors and suppliers are uninterrupted, and employees decide how the business should develop, according to their wishes and plans.

Preparing for succession

Business owners considering any form of succession planning need a strategy in place. If employee ownership as a model for succession is on the shortlist, owners must evaluate the different options as early as possible. There are a lot of things to consider as even a well-managed transition can take several years.

The owner

In a typical SME, an owner calls the shots, makes the decisions and he or she usually wears various hats including sales director, operations director, finance director, HR director and managing director at different times.  The majority of major business relationships are typically held by the owners. These can include relationships with customers, suppliers and funders. 

In order for a business to have value, the owner should begin to make him or herself less essential while nurturing management talent that will allow the company to trade successfully post exit. If looking to sell the business, the succession plan should force the owner to let go of the reigns a little – by bringing other managers through and empowering them to make decisions.

Systems

Any external buyer or funder, whether for a trade sale, or an employee led buyout will want to see that the business has good checks and balances in place. It is therefore essential to ensure that the businesses finances, process and operations of the business are organised and transparent. This will help enhance the value of the business and make the sale process easier.  Having good governance and robust systems producing good quality management information will help during any due diligence process and reassure potential funders.

The lack of quality management information, sometimes down to the most basic financial information (from Profit and Loss accounts and balance sheets to cash flow and monthly accounts) is a recurring theme in working with SMEs on succession planning.

People and culture

The culture of the business is critical as well and is an often-overlooked element when preparing succession planning. The culture, the values of the business have been at the heart of what has made that business what it is today and will help its future success. Hopefully businesses are aware of makes them different and special and will have this written down. Understanding culture and leadership will help during the succession planning process, as it is where stakeholder-value is created or destroyed.

Another reason why succession planning can take a long time is that the managers in a business may not have all of the necessary skills to effectively run the company in the owners’ absence.  There may be a training requirement, there may be the need to bring in additional skills through new people.  New employees bought in as part of a succession process will need time to settle in to the business and to become a fully functioning part of it.  Employees also need time to adjust to changes in management structures as new ways of working take time to bed in. 

Summary

What do we think business owners need to do? It starts with being proactive and starting to plan the process of ownership transfer early. This will allow you to successfully implement your ownership plan and with a strategy in place covering finance, processes, people and culture you can react to change.

Of course we would want business owners to consider employee ownership as one of the succession options. If you do go down this route, get in touch and we can help with the planning process. But whichever route a business owner goes down transferring ownership doesn’t happen overnight, and as we know from the impact of the pandemic restrictions, change can occur very quickly.

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