The ever-present succession challenge of an SME
There are approximately 14.3 million baby boomers aged between 55 and 73 living in the UK today. Many of these will be people running one or more of the 5.86*million Small and Medium-size Enterprises SME in Great Britain and more importantly one of the 247,000* businesses that employ between 10 and 249 employees. Why is this important? Because most of them will need to find someone to take over their business so they can retire. The ever-present succession challenge.
Trade Sale, MBO or…….
In an SME business that is not family-owned, the answer to “who will buy my business?” is usually a trade sale or management buyout. The former is sometimes seen as unpalatable – why sell to the competition when you know they will cut jobs, and the MBO presents management with real challenges with finding buyout finance. But what if there was a third way, selling the business to the management and employees? Last year Julian Richer of Richer Sounds sold the majority of his business to the employees and at the end of 2018 Aardman Animations of Wallace and Gromit fame did the same. They are but two of a growing number of companies choosing to sell to employees.
Why is this happening and what is employee ownership?
There has been a debate about responsible capitalism on-going for some time now, and whilst this is best dealt with in another article, there is no doubt that an increasing number of SME business owners are looking to sell for a fair price to their employees. This is partly driven by paternalism, a desire to maintain their legacy, a desire to give employees greater control over their destiny, to have a say in how the business is run and perhaps most importantly to share in the profits they have helped to deliver.
Today’s widely accepted view is employee ownership exists in a business where at least 20% of the shares are held on behalf of all employees and the business is run in such a way that people feel engaged, involved and have a sense of ownership. This of course still leaves plenty of room for other shareholders, be they individual employees – perhaps the business leaders or even external investors if appropriate.
John Lewis & Partners and Waitrose & Partners lead the field but there are about 400 other employee-owned businesses in the UK. EO businesses are now found across most sectors and unsurprisingly professional services firms make up a significant proportion of their number. Whilst this is nowhere near enough to change the capitalist landscape yet, it is the succession model of choice for many, growing at over 10% per year. Scotland in particular has embraced this model, with over 100 companies having made the move to employee ownership.
And we should not lose sight of family businesses. With around only 10% of family businesses making it to the third generation, the move to employee ownership is a very real alternative. Culturally family and EO businesses are well aligned and the motives for owner directors to sell to employees apply equally well here.
What are the challenges?
The two biggest challenges typically faced by the SME in moving to employee ownership are funding and leadership and management. In my experience, business valuations are relatively easy to agree, the issue is then finding the funds to buy out the shareholders. Talking to the company’s bank is a good starting point, although many are wary of taking on debt. Taking on external equity investors is certainly an option, but if this results in loss of control, it defeats the point of moving to employee ownership. For these reasons vendor finance is still the preferred funding choice, where the exiting shareholders fund the buyout over a number of years.
The other major challenge mentioned above is that of leadership and management. With the current owners leaving the business is there strength and depth in the next level of management to take over the running? Often the answer is not immediately, so the exiting owners stay around for a couple of years to oversee the transition.
Beyond this, there is the problem that too few owners know about the move to employee ownership as a possible succession solution. Here responsibility falls to regional accounting and legal practices, who need to ensure that their clients, who are considering retirement, know about the MEBO option.
Does it work?
The good news is that more and more business owners are finding out about this and making it happen. The 2014 Finance Act introduced some attractive tax breaks and since then more than half of all EO businesses have come into being.
Academics are now researching employee ownership and anecdotal evidence shows that these businesses are often better than similar conventionally owned competitors – particularly during tough economic conditions.
Peter Matthews has advised and helped investment in EO businesses for over twenty years now and he believes that the Post Covid-19 recovery will show that such businesses really come into their own. If you want to find out more about the MEBO option; please schedule a call on 01483 212892 or contact us here>>>
*Business population estimates for the UK and regions: 2019 statistical release – Updated 14 January 2020