Retirement for the business owner

Retirement for the business owner

Preparing for retirement can be emotional and complex, combining a need for financial security and embracing a new lifestyle. For the business owner the position is multiplied and requires much greater thought and planning for both their personal transition and that of their business.

Entrepreneurial Private Client partner Dan Hartland and corporate finance director Maria Thomas at Grant Thornton in Birmingham look at some of the key areas a business owner needs to think about when contemplating retirement and what this will mean for them and their business.

1 So what is the plan?

Often advisers will refer to the retirement of key shareholders in a business as “succession”.  Whilst “succession” can mean a multitude of things, it typically encompasses two key aspects: firstly it considers the successful continuance of the business, typically under different ownership; and secondly it considers ensuring the financial security of the retiring shareholder through realising value they have built up in the business. Both of these aspects can be addressed in a number of ways and a key first step in any successful succession plan is to identify what it means to the individual shareholder concerned.  

Whilst every succession plan is as bespoke as the individuals and businesses they relate to, we will consider the three key plans that we see most often, namely the buyout of the business by management; the sale of the business to a third party and the passing of the business to the next generation.

In all of these scenarios the name of the game is making yourself dispensable; however, how the game is played might be very different and we typically recommend a three to five year plan to ensure a successful succession.

2 Making yourself dispensable!

In the buy-out option, balanced management teams are critical to both equity and debt
funders who will likely feature here in facilitating this transition of ownership. Management teams with experience of dealing with such third parties will be invaluable by increasing the likelihood of appetite to fund and support the management team.

GT 02Whilst it involves similar preparation, where a sale of the business to a third party is contemplated, the dynamic and mind-set of the management team does take on a different perspective. In the buy-out scenario, management are incentivised by the prospect of owning the business. In contrast, the sale option involves the business owner receiving the main economic benefit. Therefore the implementation of a targeted incentive scheme, where management are rewarded alongside the key shareholder, works well to align both parties’ interests in achieving the maximum result. Perhaps the most difficult scenario can be family succession and ensuring that open and honest conversations are happening between the generations.  It is not uncommon for the next generation to feel an obligation and expectancy to carry on with the family business and for the current generation to feel an obligation to give the next generation the opportunity to do so, but with a reluctance to let go of the reins for a variety of reasons.  This halts decision making and  prevents the business from taking the necessary steps that may ultimately provide the family with a real opportunity to benefit from all of the options.  This may also affect the value of a business.

We have witnessed successful family owned businesses recruiting non-family board members to assist in maximising the options available, leading to both buy-out and sale opportunities that have created wealth for the wider family that may not have previously been achieved. The option of family succession always remains, but it is interesting how often the answer is a sale when the generations speak openly!   

3 Running the business

One of the key reasons it is important to establish the preferred succession plan at an early stage is that this may have a significant effect on the way the key shareholder runs the business in the period up to retirement.  Passing the business on to the next generation may mean a focus on generating secure revenues and transitioning relationships over time but less of a review of the external market and position of the business.  However, a trade sale may mean a far more strategic approach is taken.  By understanding the market and recent deals it should be possible to understand what will be attractive to likely buyers and which aspects of the business may generate most value.  This may affect investment decisions, potential carve outs of certain areas and positioning in the market, through to how the business presents its financial statements to ensure that the business, whilst is strategically attractive, can also stand up to robust questioning in due diligence.  

4 Financial security

Of course, ultimately the objective will also be to secure the business owner’s financial position.  This is a key consideration and, again, will differ depending on the strategy.
From a tax perspective, with the right structuring any of the above strategies can deliver a substantial capital sum that is subject to the lower rates of capital gains tax, with business owners targeting a 10% tax rate on proceeds received, up to a lifetime limit of £10 million.  It should be noted that this position is often achievable but not always achieved, and it is recommended that advice is taken at least 12 months before an exit is envisaged to avoid disappointment.

Clearly, the most straightforward position is a trade sale.  This will typically deliver not only the best value, but often the most cash up-front.  Passing the business to the next generation or a management buyout may need to be funded partly by the exiting shareholder, with such funding being repaid out of the profits of the business, often over several years.  This leaves the owner more dependent on the future success of the business. However for high growth businesses, the prospect of retaining some equity or loan notes within the business can offer an opportunity for a further return on this investment, having de-risked through the initial transaction.  

A common misconception is that leaving the business to the next generation is a purely philanthropic exercise.  Despite the connected party element, H M Revenue and Customs will often accept, through advance clearance, that passing  a business to the next generation via a Newco structure in return for cash and loan notes, to be funded from the future profits of the business over a number of years, can be taxed as capital.  This can provide the retiring shareholder with a very tax efficient cashflow to help fund their retirement, replacing dividends and salary with capital sums which are subject to the very favourable capital gains tax rates mentioned, and without overly burdening the cashflow position of the company.

5 Summary

So yes, preparing for retirement as a business owner is both emotional and complex. It requires key decisions to be made at an early stage to ensure a smooth handover of the business to a capable management team, that the business has the right strategy to maximise the value on exit and, to the extent that the exit relies on future revenues, to ensure that those revenues are achieved.