If younger generations don’t join the industry, business owners will need to think
about the future for their businesses, says Adam Bernstein.

ACCORDING to the Institute for Family Business, in its December 2022 briefing – The State of the Nation: The UK Family Business Sector 2021–2022, 4.8m of private sector firms – out of 5.6m in total – in the UK were family owned.

Of these, just 43,000 were medium-to-large. But no matter the statistics, from the sheer size of the flooring sector, it’s not hard to see that a good number of these firms will change hands each year for several reasons – retirement, insolvency or death.

Indeed, consider the March 2024 sale of Nottingham-based T&R Floor Covering Distributors to TradeChoice Carpet & Flooring. T&R Floor Covering Distributors was a family-run business with more than 45 years’ experience in the industry.

As Malcolm Trott, shareholder and managing director, said: ‘We sought a successor who shared our unwavering dedication to superior customer service.’

The question for all these businesses is how they’re passed on.

Difficult discussions
Jess Booz, partner at law firm VWV and head of its Family Business team, considers succession issues to be the elephant in the room: ‘Current and future generations often find it incredibly difficult to talk about succession, and can make assumptions about each other’s intentions which lead to misunderstandings and tension.’

She points to the PwC Family Business Survey 2021 that suggests that while most of first-generation family businesses in the UK expect majority ownership to pass to the next generation within a five-year time frame only 26% have formal, documented and communicated succession plans in place.

While succession planning does seem to be a challenge in other countries too there is evidence UK family firms are falling behind their international counterparts in this respect.

Relationships can exacerbate the problem. Nick Smith, a family business consultant with the Family Business Consultancy, says families need to think about relationship dynamics: ‘Will my children want to take the business over? Are they capable of running it? Is there room for more than one child? Will they fight? How do I deal with ownership if some want to work in the business and others don’t?’ He says these and plenty of other questions will be ever present until they’re resolved by a succession process.

The main issues
Every business needs a succession or exit plan. In the case of a growing business, family or not, there will also come a point when the current owners need to hire external talent to maintain growth. Booz advises family businesses in this situation to ‘align itself with the family dynamic or decide what to do if the two are out of alignment’.

One solution is for the family to find time away from the business to discuss the future. Family members must know that meetings are convened on neutral territory and that they are expected to speak their minds freely and honestly. A professional adviser as a facilitator can help things run smoothly.

There are two fundamental issues for Booz. When does the current generation want to retire and on what terms? Conversely, does the next generation want to take the business on, and if so when and on what terms? Smith, alternatively, wonders about an inability of the senior generation to let go of the reins of the business – ‘this can be for a variety of reasons including a lack of faith in their successor, a belief that only they can steer the business forward, or a fear of what life after the family business holds.’

Either way, Smith sees trouble.

He also thinks there’s a tricky balance to be struck between creating opportunities for the next generation and generating inappropriate expectations so that family members who are, in reality, neither suited for, nor motivated toward, life in the family business find that they spend their career in the family firm. He says that ‘this can be resolved by giving the next generation early and structured exposure to the family business, through part time jobs’.

It’s of interest that Booz sees many established family businesses wanting their next generations to forge careers of their own in other organisations or disciplines. She thinks ‘the decision to join the family business should be a conscious decision, rather than a sense of obligation, and it should bring with it the skills and experience learned elsewhere’.

Going outside the family
Of course, having family members that will join isn’t always certain. Here Smith points out, there are many examples of successful businesses still in family ownership but managed by non-family executives. ‘For this to work,’ Smith says, ‘the family will need to be deeply committed to ownership and must invest time and effort in governance so that the right balance of ownership support, supervision and control is achieved.’

If none of these ingredients are in place the best answer is likely to be to sell the firm – either a trade sale, or possibly a sale to management. And it’s for this reason that, Booz’s colleague, corporate partner Sam Chaney says advice on value and likely exit options from an experienced corporate finance adviser is necessary: ‘Your accountants may be able to help, but also ask for recommendations from your other advisers.’

Sale and no pass-down
But if there’s no likely successor on the horizon, the only option may be a sale of the business. On this Smith says families often choose to sell to a buyer who they believe is most likely to preserve the culture and ethos of the family business; often another larger family-owned company.

But once the decision has been taken Chaney says the family should take advice on valuation and sale options: ‘This is one of the biggest decisions you’ll make in your business life and it’s important to get good advice and be prepared to pay for it.’ She advises seeking recommendations but notes that the sort of advisers that will be engaged will be dictated by the size and complexity of the business.

Further, she says to ‘think hard about engaging people who work principally on a success fee percentage commission-only basis – the overall cost may be higher, although you may be insulating yourself from costs if a deal doesn’t go ahead – but there can be a conflict of interest for people remunerated only if a deal goes ahead’.

One thing that will ease the process is to undertake some financial and legal due diligence as if the seller were a buyer, to identify any gaps or issues that may affect price or saleability. Internal due diligence also means the firm is prepared for what the buyer’s lawyers will be asking for in due course.

Seeking a valuation
Whether through pass-down or sale, the business will need a valuation. Businesses will generally be valued on one of three bases – the value of net assets plus a valuation of goodwill; a multiple of earnings; or discounted future cash flow.

Smith has seen some families ask the next generation to pay the full market value for their interest. But he’s also seen situations where shares are just given.

‘In between the extremes,’ he says that ‘there are a raft of approaches and solutions including discounted prices and stage payments. There are also more complicated solutions such as freezer share mechanisms, where no sale takes place but the senior generation lock in the current value of their shares to be left to the wider family and the next generation family members actually working in the business receive the benefit of any growth in value during their time in charge’.

But what of an arm’s length sale? Here Chaney says: ‘The family will ideally want to be paid in cash, in full, at completion, rather than risk the possibility of deferred consideration not getting paid because the business gets into difficulties under its new owners, or a dispute arises over what should be paid.’

But that, she says, may not be possible, and there may be many good reasons why the retiring shareholders keep an equity stake or agree to be paid overtime or agree that some of what they get paid is subject to future performance. Even so, she suggests starting with the idea of the ‘clean break’ and working back from there if you have to.

Going beyond the sale comes the problem of divvying up the proceeds. Is this to be done collectively through a family office or will each family member take their own share of the pot to do as they want with?

Tax planning and family succession
As might be expected, tax planning is important and should always form part of the decision-making process but should never be the main driver. That said, no-one wants to hand over, by way of inheritance tax, value from what they have worked for.

Both Smith and Chaney consider tax planning key. Says Smith, ‘the most important point is what is right for the family members and the business itself’.

He believes the UK offers a fairly benign tax-planning environment for family business succession so that many family businesses, depending on value, can be passed on free of inheritance and capital gains tax to other family members.

However, the risk of paying a bit of tax pales into insignificance if passing on the family business to the next generation means passing on a working lifetime of misery and a failing business.

Chaney adds that if business asset disposal relief is available, the effective rate of capital gains tax is just 10% up to a lifetime allowance of £1m.

In summary
The flooring sector has a bright future and needs to encourage the younger generations to join. But if they don’t then business owners do need think about the future for their businesses. They may feel invincible now, but damaged knees, old age and mortality awaits them all.
Adam Bernstein is an independent columnist