Business succession – exit options and financing arrangements

In business all good things come to an end unless there is a successful transition to the next generation or team who will continue to run it.

Not every business is sold or passed onto the next generation. In January, the successful team at Le Gavroche hung up their aprons and closed the doors after 57 years at their Brook Street restaurant. Started in 1967 by the Roux Brothers and run in recent years by Michel Roux Jr, he chose to close the doors on the two Michelin-starred London restaurant rather than sell up.

For many business owners especially those who don’t have a family member who is willing or able to take on the business, simply closing the doors and walking away isn’t an option. Their goal will be to realise the cash value of the business via a trade sale. It is essential to prepare your business ahead of any sale to achieve the best price and outcome.

After the due diligence process and business terms being agreed, typically a lump sum payment is made to the shareholders sometimes with further payments for the balance being made amount over a period of time. This maybe dependent on the owner staying on for a transition period and / or certain performance targets being met – the latter being known as ‘earn outs’.

Unsurprisingly this arrangement doesn’t appeal to everyone, especially those who want a clean break and there are alternatives such as a management buyout. This is where the existing management team have the skills and appetite to buy the business in its current form and often an existing share scheme will be used to assist with share acquisition allow them to buy the business at either the full or a discounted rate. Affordability can be a challenge here and exiting shareholders will often agree to take their money over a period of time which we typically refer to as ‘vendor finance’.

Another option is to create an Employee Ownership Trust (EOT). This can be done as part of the succession planning strategy to allow the current owners to exit and has the advantage that those selling their shares can do so free of capital gains tax (subject to a few exemptions). The EOT must own a controlling interest i.e. over 50% of the shares in the business as a result of the transaction. The business should be valued by an independent expert and payments will be made in instalments funded by the contributions from the company to the EOT out of future profits of the business unless the exiting owner gifts their shares to the EOT for nothing. Sometimes external funding might be sought to pay for the shares up front which allows a clean break for the previous owner but this is not easy to secure.  Going forward the trust then holds the shares of the business and is run by a Board of employees and possibly previous owners.

How are purchase options financed?

• Bank loan – most banks offer commercial lending which can be used to acquire a business. Rates and terms will vary as will lending covenants, so it is advisable to shop around.
• Private equity loan – from a private investor or a venture capital fund but they will typically charge a higher interest rate than a bank and often require an equity take. They may however offer more flexible terms which are tailored to the individual transaction.
• Asset backed lending – this uses the assets of the business as collateral for the loan.

Typically, lenders will want to share the risk and investors will be expected to contribute between 10-30% of the sale price. Whichever finance option you choose, it is important to fully understand any conditions attached to the agreement to avoid breaching loan covenants.

If you have the right advisors on board, you can make sure that the business is bought or sold using the most tax efficient means for all parties.

Family Investment Companies are another popular vehicle at the moment for wealthy families looking to grow and preserve wealth for future generations which includes buying and selling businesses, shares and assets, but it is important to get the structure right. Understanding what individuals want to achieve with their wealth is important and my colleague Liz Cuthbertson will look at this subject in much more detail in the next article in this series.

Advising business owners is what I have done for a number of years and whilst every business and its owners are different, there are many similar scenarios that I come across. Choose an advisor to help you move on from your business who will look at the whole picture so you can confidently plan your next move in life knowing your wealth and your future is protected. Contact Jacqui Gudgion or a member of the Mercer & Hole team to discuss planning ahead for your future.