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Selling a family business? What's the best option?

17th Sep 2019   ·   The ThinCats Team   ·   Insights

Britain’s very oldest family businesses have passed from generation to generation for almost half a millennium. The oldest of all – Dorset-based butchers R J Balson & Son – dates back to 1535, the year of Thomas Moore’s beheading for being a bit foot-draggy on Henry VIII’s break with Rome. 

For many, this succession from parents to offspring is a model that has worked well, and will continue to do so. But there will also be many other businesses where the next generation has other plans. The question then is, what’s the best form of transition?

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Funding Succession:

Navigating the transition in business ownership

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Family traditions without the family 

For business owners who want to see a continuation of the culture and values they have built into the business, effect a smooth handover, and reward their staff, employee ownership could be a good solution.

Employee ownership is seeing an acceleration in growth. In 2019, there are now more than 1,100 throughout the UK. In 2018, the Scottish government set a target of increasing the number of employee and worker-owned businesses there from 100 to 500 by 2030. That’s a healthy trend but, considering there are more than 5m businesses listed in the UK, there is still much untapped potential.

A very effective way of making this transition – not least, in tax terms– is through an Employee Ownership Trust (EOT). The EOT is a form of employee benefit trust, with particular features and tax advantages (see below). EOTs hold a controlling stake in the underlying firm and are legally required to benefit all employees on an equal basis.

Tax Benefits

For the seller

There is a total capital gains tax (CGT) exemption on all gains made when a majority interest is sold to an EOT. In a ‘conventional’ sale, on the other hand, the seller would pay 10% CGT after entrepreneurs’ relief.

For the employee

Under Schedule 37, the company is allowed to pay annual tax-free cash bonuses of up to £3600 per employee. Because it is a bonus, not a dividend, the company does not have to be in profit.

 

According to the Co-op’s recent report, SME and family owned businesses are particularly suited to the EOT option, because this “allows for a phased, full or partial, transfer of equity and control which locks in collective employee ownership and stewardship of the business for the long term, whilst protecting local jobs and supply chains. Trusts can be designed to allow for genuine accountability and voice for employees, which is not always the case in wider employee shareholding models.” What’s more, according to the Financial Times, “there is evidence that, combined with wider participation in decision making, [employee ownership] can raise productivity as well as growth. That applies in many industries, but especially in professional services where creativity matters.”

Recent high-profile examples of EOTs include the makers of Wallace & Gromit, Aardman Animations (Wallace, alas, being a confirmed bachelor with no progeny) and hifi high street chain Richer Sounds.

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Benefits and barriers

Selling to employees can often be easier than other forms of sale, less antagonistic and quicker, given the parties all know each other and the business. The due-diligence process is more straightforward, as the potential buyer will know the business from the inside out, and the seller doesn’t have to hand over commercially sensitive information to a potential competitor.

Lack of understanding and knowledge have been identified as key barriers to the broadening out of this ownership structure. The ability of the buyers to access suitable finance can also be an issue, as can be tapping into the expertise in structuring such a deal. While a few banks have stuck their toes into the water, they are not overly keen on such financing. Tighter lending criteria since the global financial crisis have caused them to rein in ‘riskier’ lending, not least to SMEs, as has a loss of on-the-ground expertise through the need to cut costs. This is a complaint we hear a lot from entrepreneurs – of banks simply not understanding a potential borrower’s business well enough to make an informed decision.

Banks’ reluctance to lend is particularly evident with regard to cashflow loans, as opposed to loans secured against fixed assets. Unfortunately, most transactions using companies’ resources fall into the category of cashflow loans.

This is where alternative lenders such as ThinCats come into their own. Not only are we unencumbered by the red tape that limits bank lending, but we have the expertise to determine how good a proposition each business is, and can structure an individually tailored finance package on that basis. Examples of successful funding of EOTs we’ve financed include Midlands-based Specialist electrical and civil engineering contractor P&D and Scottish IT firm Network ROI.

Want to learn more about exit strategy planning?

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