The future of family business in pandemic recovery
The new financial year has begun. It is the first financial year post-lockdown, with the new challenges that the pandemic has brought to the table. In what way has the pandemic broadened the scope of the agenda for business owners who are looking to retire or sell within the next couple of years?
Many strategic business decisions are likely to have been put on hold over the past 15 months while governments around the world have dealt with the pandemic. But now that we see indicators of the economic recovery, where does that leave business owners who are ready to think about the future?
Succession and continuity planning are key for family businesses and is a topic that is being discussed more openly by business owners than it has been traditionally. Whether the decision is made to pass on ownership to future generations or employees, or whether a third-party sale is being considered, possible strategies should ideally be contemplated long before an actual exit is effected.
The current outlook for the UK economy is positive, and for many the financial effects of the pandemic may not be as bad as originally feared. Time will tell if this is the case, but when investors are in a buoyant, positive frame of mind, deal flow and M&A activity usually follow.
There are substantial funds available for the right investment opportunity. Traditional investors, such as private equity houses and hedge funds, will be keen to target quality businesses. But other investors, such as sovereign wealth funds, SPACs and indeed well-resourced trade buyers, are also increasingly active. As such, there are numerous types of deals to be done and potential buyers with which to do them, many of whom are ready to move swiftly to snap up well-run businesses.
There is also the matter of interest rates. These have two interesting dynamics, the first being the availability of cheap financing for buyers looking for additional cash to fund an acquisition. The second is that with interest rates being so low, investors are looking for more interesting opportunities, aiming to put their funds into different asset classes.
So, having established that there is a current market for sales and acquisitions, what acquisition terms are we seeing or expecting to see, at least in the short-term future?
Notwithstanding the economy’s prospects, buyers are treading cautiously in terms of structuring consideration. There is still uncertainty in the market, and buyers are negotiating the purchase price accordingly. Deferred consideration, especially earn-out clauses, is being increasingly agreed. These provide that a buyer will pay a certain amount of the purchase price up-front on completion with the remainder being paid at a given point in the future conditional on the target’s performance over a certain period. While this allows the seller to benefit from some liquidity immediately on completion, it also allows more time for economic conditions to balance out and for the buyer to share part of the risk.
Earn-outs can also result in the seller receiving an overall larger payment than they would have done otherwise. Where the parties agree that the deferred amount will depend on the target’s performance and revenue, a successful earn-out period for the target can be a win-win situation for both the buyer and the seller. But it should be remembered that a deferred consideration structure prevents a seller from achieving a “clean break”, and their interests will be entwined with those of the business throughout the earn-out period, which may be a few years.
Buyers are also undertaking thorough due diligence, particularly in relation to areas which have been impacted by the pandemic, such as employment, furlough and home working arrangements. This can result in a longer transaction timetable and a heavier administrative and documentation burden being placed on the seller. Those considering a sale would be advised to have such documentation in order so that they can swiftly respond to buyers’ queries.
Trust in employee ownership
An alternative to the traditional third-party sale and a structure which has been gaining momentum recently is acquisitions by employee ownership trusts (EOTs). This arrangement comes with potential tax benefits , allows for a simpler, and therefore cheaper and speedier, transaction, renders earn-out or other deferred consideration provisions unnecessary, and increases employee motivation. For certain businesses and sellers, EOTs can provide an optimum exit strategy.
The future for the M&A sector appears to be fairly rosy, and for anyone considering an exit there are plenty of willing investors out there. However, as with any significant business transaction, getting the right advice and negotiating advantageous terms will make the difference between a good transaction and a poor one.