Small business owners approaching retirement have a number of options for disposing of the company when the time finally comes, but each has its own inherent problems
How many times have advisers involved in the business market sat in front of the director of a small owner-run company or partnership and discussed pensions? Quite frequently, I would imagine.
How often have they asked: what happens when you go? Are you just going to lock up on the Friday after your 65th birthday and walk away?
In the vast majority of cases, I get a very startled look. Few have made concrete plans and most have only a vague idea of what will happen.
There are usually four scenarios:
• They will sell the business.
• The next generation will take over as they have a son/daughter in the business who will run it.
• They will sell it to the existing management.
• They will never retire.
Each of these has its own innumerable ramifications. I am only referring to small companies but there are nevertheless issues that can be transposed into larger companies.
Looking at the first issue, selling the business, the major questions are when and to whom? If it is left too late, it looks far too much like a forced sale, which generally attracts vultures.
Selling a business is a difficult and delicate task and requires the assistance of experts. In general terms, it is far better to receive an unsolicited offer for the business rather than tout it around for a buyer. In the main, unsolicited offers are often the result of good PR work.
Many who wish to buy a business actually wish to steal it. Some companies on the acquisition trail have eyes bigger than their bank accounts and their idea of negotiation is to start with a figure so ludicrously low it bears no relation to anything at all.
Obviously, the value of anything is how much somebody is prepared to pay for it and the corollary is that vendors often have an inflated idea of what their business is worth. Finding the middle ground is no easy task and an accepted method of valuation is hard to come by. For every argument espousing value, there is another equally valid argument to denigrate it.
Then, of course, there are the murky waters of installment payments and earnouts. Several years ago, a client had already agreed an installment payment by the purchaser and had received two years worth of payments on a four-year schedule.
His problem was that the purchaser looked like going bankrupt. The solution was that the vendor ended up re-owning his business, which was hardly satisfactory.
The issue of sons or daughters taking over also poses problems. Are they capable of running the business? This is not always a given.
Will the retiring person continue to earn a salary or take dividends as long as the children are running it and are they prepared to stand still and see a non-productive member do this? Can the retiring person bear to leave things alone and let them get on with it?
The next question is that if the retirees are serious and the children do take over, where are they going to find the money from? How long in the future are we looking at? If it is long enough, various sensible schemes could be put in place to accumulate cash.
Many of the same problems arise with management buyouts. Does the management have the wherewithal to raise the money?
The final issue is people who never intend to retire. On the face of it, this is the easiest to plan for, as all you need is life assurance, provided the client is young enough. But what about the staff or the embedded value of the business? Is that all to go to nothing because the client will not plan?
A further option, never initially considered but sometimes well worth looking at for cash-rich businesses with few staff, is liquidation. Provided extreme care is taken as to who will perform the liquidation, this can be a neat and effective way of getting out. However, one client took this route without prior consultation and ended up paying the bulk of the proceeds in liquidation fees.
Many of the above questions form the framework for pension planning, key person assurance and shareholder protection, but these products often do not fulfill the entire need and the answer may lie with non-investment or insurance products.
The sale of the business under the current tax regime is often a much better bet than any form of pension planning and far more cost effective. The best thing to do with surplus cash is often to re-invest it in the business. Yes, it increases risk, and it is always a good idea to diversify risk but there is nothing to stop people buying another business.
While people are working, they are enjoying the fruits of their labours and a successful business can certainly provide attractive compensations.
The advice of salesmen who say that the only way to avoid tax is to put your money with a life office that, in the present circumstances, can dissolve it at the speed of light, does not have to be followed. The tax breaks afforded to those selling businesses are such that a real ethos of entrepreneurship is engendered to those astute enough to take up the challenge.
A German client with subsidiary companies in the UK, the US and Singapore found the UK business was making handsome profits. His biggest problem was what to do with the money. He had done the rounds of various advisers, who were all on the tack of trying to put it in his own pocket, which was not very tax effective.
The solution, with which he seemed quite pleased, was to utilise the surpluses in the UK company to buy an additional business. He didn't need the money and wanted to put it to the best use. He now has a haulage company based in Calais that operates in the UK and France distributing the products the UK company stocks.
Adding value to clients does not have to include the products from the fund management or insurance industries when planning succession. However unenviable it may be to some, this kind of work does involve fee charging. In this market, the fees some advisers (bankers, accountants, lawyers) charge are astronomical. The rewards an adviser might receive would look bargain basement by comparison.
Harry Katz is principal of Norwest Consultants
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