What is the succession plan for your business?

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There are a number of ownership succession options available to private businesses in Scotland.

A one-size-fits-all approach to business succession is unhelpful as every business and business owner is unique.

The most successful ownership transitions occur when business owners have had an opportunity to explore and appraise all of the succession options available. Only then can a bespoke succession plan be prepared that meets the individual needs and objectives of exiting owners and their businesses.

Why are Succession Objectives important?

Louise Fisher, Senior Legal Manager at Baxendale Employee Ownership said, “Considering the relative importance of a number of key succession objectives is at the heart of successful succession planning.

“Business owners should ask the following questions to understand what’s important to them: Is it important that the business carries on its current business activities in the future? Should the business remain in its current location and retain the business name? Do the owners wish to continue to have a role in the business? Is it important to sell the business for the highest possible price? Is a large day one payment a key requirement? Is maintaining customer / supplier relationships of high importance? Is job security for current employees desirable? Is it important to retain key employees?”

What are the available Succession Options?

Louise continues: “Once the key succession objectives have been identified, it is important to explore and appraise all the succession options available before a succession plan is created.”

Below is a summary of the most common succession options that are available and some of the advantages and disadvantages of each of these.

Trade Sale

A trade sale involves an independent third party buying the business from the current owners. Most commonly the transaction will involve the payment of some cash to the sellers on day one and a proportion of the sale price will almost certainly be deferred with lock-ins for the key employees for a period.

It is also usual for extensive due diligence to take place which can be time consuming and sometimes disruptive for the business. However, a trade sale should be the succession option that enables business owners to realise the highest price - if you find the right buyer.

Management buyout

A management buyout (MBO) involves the management team of a company buying the company they manage from its current owners. Usually this will involve the management team setting up a new company to buy all the shares in or assets of the business from the exiting owners.

The precondition for an MBO to be a viable succession option is of course the existence of a management team that is willing to buy the shares and has the capital to invest to buy out the current owners.

They will be asked to give guarantees to lenders and the exiting owners that any deferred consideration (debt) will be paid over an agreed time period.

However, if the correct management team is in place to take over running the business, the viability of the business and continuity for its employees is secured via an MBO.

Family succession

A family buyout (FBO) is where ownership and often leadership of the business transfers to the next generation of family members and the senior generation can extract cash for their shares.

An FBO secures family ownership of assets and independence and continuity of the business and its values and preserves employees’ jobs for the long term.

However, as the majority of the sale is usually raised from the current assets and future profits of the business, the sellers will need to wait for some years for all of the price to be paid to them.

A longer-term succession question is also raised in the FBO model. Very few family businesses make it to the third generation of owners so what will happen to the business and its employees when it’s time for the next generation owners to retire?

Employee ownership

Employee ownership (EO) is where all the employees of a business have a significant and meaningful stake in that business.

This usually means that the majority of ownership is transferred to the employees and employees can have a voice in decision making. There are 3 forms of EO.

In the direct ownership model, employees become individual shareholders in their companies. Shares are usually acquired using a tax efficient share scheme.

As direct shareholders, employees can influence the direction of the company and can benefit financially through dividends as the company grows.

However, employees would need to be in a position to use their own cash to purchase the shares. Most companies would oblige employees to sell their shares when they leave the business.

Indirect ownership is where some or all the shares are held collectively for the benefit of all the company’s employees, usually using an employee ownership trust (EOT).

The EOT model gives employees many of the benefits of ownership without them being obliged to buy shares directly with their own money.

An EOT provides a stable ownership base for the continuation of the business as an independent entity. The introduction of an EOT also supports good governance of the business as there is usually some employee representation on the EOT.

The vision and values of the business and the exiting owners’ wishes for the preservation and extension of the business’ culture – what makes it unique – are often expressed in the documentation establishing the EOT.

Many business owners choose a hybrid or blended model of employee ownership as their succession solution.

In this model, the majority of the shares in the company will usually be held by an EOT, and some of the remaining shares or options over shares will be made available to employees as a way to incentivise key employees in the business.

As in the MBO and FBO models, the majority of the sale price is usually raised from the current assets and future profits of the business and therefore the sellers will need to wait for some years for all of the price to be paid to them.

However, if structured appropriately, an EO transition can involve no Capital Gains Tax being payable and bonuses free from income tax being available to employees – at the moment bonuses of up to £3,600 per annum can be paid to employee’s income tax free.

A bespoke succession plan

Louise concludes: “When a business owner has explored all the succession options available and considered their succession objectives, it is time to begin to look at the most appropriate succession solution and prepare a bespoke succession plan.

“If for example, if a key succession objective is to sell the business for the highest possible price with the business remaining in its current location and leaving a legacy for future generations being of less or no importance to a business owner, exploring a trade sale in more detail may be appropriate.

“Alternatively, if job security for current employees and retaining business culture and values are of high importance, and the owners being paid all their cash on day one is less important, we would begin to think about a potential EO succession solution for the business.”

Starting your succession journey

Glen Dott, Succession and Employee Ownership Specialist at Scottish Enterprise said: “It’s never too early to start your succession plan. Identifying the succession solution that meets both the business’ and business owners’ succession objectives is the first step on that journey.”

Scottish Enterprise can help business owners explore their succession options. Start your succession journey today by:

Attending a free online ‘selling your business masterclass

Contact us via the Scottish Enterprise website call us on 0300 013 3385

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