By Adam Bernstein, Monday 05 February 2018
In a digital era of technological change, family-owned printers need to make a succession plan – fast.
According to the Institute for Family Business (IFB), two thirds – 4.7m in total – of UK businesses are family owned. Of these, some 17,000 are medium-sized to large, and collectively they generate more than a quarter of the UK’s GDP. They employ around 12.2 million people and make up about 47% of private sector employment.
Crucially, the IFB believes that around 100,000 of these firms change hands each year for a number of reasons, such as retirement, insolvency or death.
The question for all family businesses is how they are passed on, and it’s one that is illustrated by three family-run printers.
Take a 150-year old print firm, GH Smith & Son. Director Rupert Smith and his brother are the sixth generation of his family to run the business. “Our parents are of retirement age and wanted to take a more back-seat approach. It has been a gradual process over the past 15 years,” he says.
Matthew Ronnie, managing director of Solway Print and The Edinburgh Print Company, a 45-year-old second-generation commercial printer, found his company in the same situation. “The first generation was looking to retire and we needed to roll out a succession plan. Lots of meetings and discussions later culminated in the daughter of one director and son of another joining forces to replace their fathers,” he says.
Teri Baron, managing director of Rotary Creative Print, put her desire for transition to the third generation down to opportunity. “I had the opportunity to bring new ideas on board when I was a thirtysomething so now it is time for me to nurture the next generation,” she says.
David Emanuel, partner at law firm VWV and head of its Family Business team, considers succession issues to be the elephant in the room for family-owned businesses. “Current and future generations often find it incredibly difficult to talk about succession, and they can make assumptions about each other’s intentions, which lead to misunderstandings and tension,” he says. He points to a recent PricewaterhouseCoopers (PwC) Family Business Annual Survey, suggesting that 30% of family businesses make it to the second generation, 12% to the third, and 3% to a further generation.
Relationships can exacerbate the problem. Nick Smith, a consultant at the Family Business Consultancy, says families need to think about relationship dynamics. He says, “Will my children want to take the business over? Are they capable of running it? Is there room for more than one child? Will they fight? How do I deal with ownership if some want to work in the business and others don’t?” These and plenty of other questions will be ever present until they’re resolved by a succession process.
The main issues
Every business needs a succession or exit plan. In the case of a growing business, family or not, there will also come a point at which the current owners need to hire external talent to maintain growth. Emanuel advises a family business in this situation to “align itself with the family dynamic, or decide what to do if the two are out of alignment”.
One solution is for the family to find time away from the business to discuss the future. Family members must know that meetings are convened on neutral territory and that they are expected to speak their minds freely and honestly. A professional adviser acting as a facilitator can help things run smoothly.
There are two fundamental issues for Emanuel. Does the current generation want to retire, when, and on what terms? Conversely, does the next generation want to take the business on, and if so when and on what terms? Smith wonders about an inability of the senior generation to let go of the reins. “This can be for a variety of reasons, including a lack of faith in their successor, a belief that only they can steer the business forward, or a fear of what life after the family business holds,” he says. Either way, Smith sees possible trouble.
Starting the process
The problem that many in the sector face is finding those in the family who want to enter print. Rupert Smith is typical of those in that situation. “My son says he is not interested, but I do have a couple of younger nephews who may want to join the family business when they reach working age,” he says. “If we don’t get any family interest then we will have to look at different measures, this is an age-old problem that confronts all family-based businesses, continuation – and how to achieve it.”
Interestingly, Emanuel sees many established family businesses wanting their next generations to forge careers of their own in other organisations. “The decision to join the family business should be a conscious one, rather than having a sense of obligation. It should bring with it skills and experience learned elsewhere,” he says.
Baron agrees: she has two daughters and her eldest wanted to work in the business whereas her youngest wanted to pursue a career as a fashion designer. “They understand that they have both had the opportunity and there is still time if the younger one changes her mind,” she says. Baron adds that she will pass down the shares when she retires and has made provision for the younger one not to miss out.
But that said, Ronnie reckons that one of the most useful things that Solway Print did was to bring in someone who didn’t have industry experience. “Someone asked silly questions about why things were done in a certain way,” he says. “‘Because we have always done it that way’ was not allowed as a reply.”
For Nick Smith, there is a tricky balance to be struck between, on the one hand, creating opportunities for the next generation, and on the other, bringing inappropriate expectations so that family members who are, in reality, neither suited for or motivated towards life in the family business find that they spend their working life in the family firm.
“This can be resolved by giving the next generation early and structured exposure to the family business through part-time jobs,” he says. According to Smith’s thinking, identifying the successor is a long-term project. It is arguably one that starts in childhood.
Luckily for Solway Print, the succession process has worked out well. “There were two founders and two of us in the right place to take over. There was an equal partnership and that’s what has continued. If there had been others involved or unequal shareholdings, it might have been a different story,” says Ronnie.
Going outside the family
Of course, having family members join the firm isn’t always certain (or even wanted). As Nick Smith points out, there are many examples of successful businesses still in family ownership but managed by non-family executives. Lego is a good example. “For this to work,” says Smith, “the family will need to be deeply committed to ownership and must invest time and effort in governance so that the right balance of ownership support, supervision and control is achieved.”
If none of these ingredients are in place, the best answer is likely to be to sell the firm – either as a trade sale, or possibly as a sale to management. It’s for this reason that Emanuel says advice on value and likely exit options from an experienced corporate finance adviser is necessary. “While your accountants may be able to help, ask for recommendations from your other advisers,” he says.
Planning for the unexpected
Death and divorce are two obvious risks for a family business. As Emanuel notes, the death of a co-owner can lead to a loss of vital skills and experience, as well as the risk of shares passing to an unknown quantity, or a need to fund the purchase of those shares to provide some value for the deceased co-owner’s family. Divorce principally presents the risk of shares passing outside the family, or a need to sell shares to finance a divorce settlement. “Families must think about what should be done in these circumstances and consider a shareholder’s agreement to cover these issues,” he says. For Nick Smith, this might be considered unromantic, but it’s “infinitely preferable to having the divorce courts decide the fate of the family business.”
Emanuel offers another option, where some family companies will have classes of shares, which can only be held by defined categories of blood relation as a way of ensuring that shares stay within the family. Baron has done something similar. She says there’s an agreement in place, allowing for only family members who work within the business to benefit from the business. “Other family members would benefit from legacies outside the family business that have equal monetary value,” she says.
But no matter the planning undertaken, there’s a need for what Nick Smith calls
a “plane crash drill” where the business tests succession and contingency planning. “If the business would crash alongside the business leader, more managerial responsibility may need to be handed over to the successor sooner rather than later,” he says.
To cover untimely death, key man insurance is an option; it provides a fund to buy out the deceased shareholder’s shares. As for having a good will in place, it won’t deal with aftermath of death. It will only handle the owner of shares following the owner’s demise. Even so, wills are on Rupert Smith’s radar. “We are of an age where we need to plan for all eventualities,” he says.
Ronnie has thought carefully about the future too. “We all have robust wills and have planned for the worst to ensure that the business will continue should anything ever happen,” he says.
Sale and no pass-down
If there’s no likely successor on the horizon, the only option may be a sale of the business. Here Nick Smith says that families often choose to sell to a buyer who they believe is most likely to preserve the culture and ethos of the family business, often another larger family-owned company.
But once the decision has been taken, Emanuel says the family should take advice on valuation and sale options. “This is one of the biggest decisions you will make in your business life and it is important to get good advice, and be prepared to pay for it,” he says.
So he advises seeking recommendations but notes that the sort of advisers who will be engaged will be dictated by the size and complexity of the business. Furthermore, he recommends “thinking hard about engaging people who work principally on a success fee percentage commission-only basis. The overall cost may be higher, although you may be insulating yourself from costs if a deal doesn’t go ahead, but there can be a conflict of interest for people remunerated only if a deal goes ahead.”
One thing that will ease the process is to undertake financial and legal due diligence as if the seller were a buyer, to identify any gaps or issues that may affect price or saleability. Internal due diligence also means the firm is prepared for what the buyer’s lawyers will be asking for in due course.
Seeking a valuation
Whether through pass-down or sale, the business will need a valuation. Businesses will generally be valued on one of three bases: the value of net assets plus a valuation of goodwill, a multiple of earnings or discounted future cash flow.
Nick Smith sees some families seeking for the next generation to pay the full market value for their interest, and other situations where shares are just given.
“In between the extremes,” says Smith, “there are a raft of approaches and solutions, including discounted prices and stage payments. There are also more complicated solutions, such as freezer share mechanisms, where no sale takes place but the senior generation locks in the current value of their shares to be left to the wider family and the next generation family members actually working in the business receive the benefit of any growth in value during their time in charge.”
What is Rupert Smith’s view? “A gradual approach to valuation rather than a lump sum payment, which helps to keep the business on firm footings,” he says.
But what of an arm’s length sale? Here Emanuel says, “The family will ideally want to be paid in cash, in full, at completion, rather than risk the possibility of deferred consideration not being paid because the business gets into difficulties under its new owners, or a dispute arises over what should be paid.”
However, that may not be possible, he says. There may be many good reasons why the retiring shareholders keep an equity stake or agree to be paid over time or agree that some of what they get paid is subject to future performance. Even so, he suggests starting with the idea of the “clean break”, and working back from there if you have to.
It’s important to remember that in a succession situation, where one generation is passing the business to the next, and the retirees are expecting a payment of value to cover their retirement ambitions, deferred payment risks may be looked at differently, depending on the circumstances – families will be more trusting.
Going beyond the sale comes the problem of adding up the proceeds. Is this to be done collectively through a family office or will each family member take their own share of the pot to do as they want with?
Tax planning and succession
As might be expected, tax planning is important and should always form part of the decision-making process, but should never be the main driver. That said, no-one wants to hand over, by way of inheritance tax, 40% of the value of what they have worked for.
It’s a problem Rupert Smith has identified. “The biggest issue we faced was making sure that if our parents died, we were not stung with tax. Measures were taken to structure our companies so the transition could take place with no cost implications, a process which took a number of years. We now have a structure which should suit all those concerned,” he says.
Both Nick Smith and Emanuel consider tax planning to be key. “The most important point is what is right for the family members and the business itself,” says Smith. He believes the UK offers a fairly benign tax-planning environment for family business succession so that most family businesses can be passed on free of inheritance and capital gains tax to other family members. However, the risk of paying a bit of tax pales into insignificance if passing on the family business to the next generation means passing on a working lifetime of misery and a failing business.
Emanuel adds that if the Entrepreneur’s Relief scheme is available, the effective rate of capital gains tax is just 10%.
Print has many facets that should encourage the younger generations to join the industry. Rupert Smith sums up how he sees the future. “When you look at how digital technology has changed the industry over the past 20 years, print is definitely cutting-edge and should appeal to the young people of today. The sky is the limit,” he says.
However, for Ronnie, who has a two-day old son, and his business partner, with a seven-year-old son, the future is a way off. As for Baron, she now gives support and trust to her daughter. “Nothing would make me prouder than to see her succeed and take our family business to the fourth generation,” she says.