The Owner-Manager Retirement Trap

The Owner-Manager Retirement Trap

“Retirement is the ugliest word in the language” said Ernest Hemingway. For many small business owners this often rings true. When you’ve put your heart and soul into building a business over the years, letting go of the reins can be a very tough decision to make. Even if you’re ready to walk away, many owner-managers end up feeling trapped, unable to find a buyer for their business and working-on well past their planned retirement age, with dwindling motivation.

Every situation is different of course, whether you are looking for a clean break, to carry on as long as possible or to transition from “living to work” to a less hands-on role, where your business provides an ongoing interest as part of a more relaxed way of life in retirement. There are challenges with every option and as ever, preparation and planning are key to realising your goals.

According to the Forum of Private Business in 2015, 59% of business owners intended to sell their business to help fund their retirement. This is not a surprising statistic but in our experience, we would estimate at least two thirds of businesses marketed for sale don’t find a buyer, resulting in the owner-manager staying in the business and ultimately pushing back their retirement plans.

Alongside continuing to operate the business, the owners often find themselves spending additional time working to enhance its saleability before trying to sell again in a year or two’s time having “exposed itself” to its competitors in the previous attempt to sell. All pretty disruptive for the owner, business and staff.

If you consider the ONS statistics for sales of all types of UK businesses, on average from 2009-17 there were only about 500 transactions per year (above £1m value, selling >50.1% shares) which seems like a very small number relative to the 245,000 small and medium sized businesses (10-249 employees) in the UK in 2018.

Selling up at retirement seems to be the goal for the majority of owner-managers but for many, this ends up being far more difficult and time consuming to achieve than they expect. Why is this?

These businesses may be well-established and consistently profitable but still don’t attract a buyer. In our experience as both investors-in and advisers-to SMEs, there are a few key areas that owner-managers should consider to help navigate this retirement trap…

Is the owner-manager the key asset of business?

Many owner-managers hold the critical customer and supplier relationships and buyers may consider this intellectual property the most valuable part of the business. This can be a major concern for buyers worried about the sustainability of the business under new ownership.

Gradually transferring these relationships from the owner-manager to the senior management team can mitigate this but this is clearly not an overnight fix. Many years of planning are often required to ensure the right people are in the right positions so that the business being sold genuinely “owns” these relationships.

The well-trodden compromise here is for a portion of the sale value to be deferred, making it conditional upon the performance of the business under new ownership, which is obviously not ideal for the vendor who is handing over control of the business whilst wanting to protect their deferred consideration – an uncomfortable compromise.

The business may or may not need a replacement for the retiring owner-manager depending upon the buyer but if the key relationships have been ‘handed down’ to the management team, this should help achieve the highest value and cleanest exit at retirement.

Maximise your chances of finding the best buyer

You may spend a lifetime building value in a business and it has probably generated a very comfortable living but, for many, the pay-day when finally selling your company is the most important of all.

The team here at Seneca have come across almost every scenario you can imagine, from owners selling up over a pint in the pub to trying to hire City investment banks to sell their companies, before discovering their fees will be more than the value of the business!

There is no right or wrong way to do it, in our opinion the key is good, old preparation. “By failing to prepare, you are preparing to fail” said Benjamin Franklin. And you only get to sell your business once so it’s worth doing it properly.

So…where do you begin?

A good place to start is getting to know more about the process of selling a business.

Initial discussions with your accountants, corporate finance advisers, lawyers and potential investors can be held without commitment or cost and are incredibly useful in helping formulate your own objectives and testing how realistic they are. Quietly engaging in these discussions a few years before you plan to retire is quite sensible.

When committing to starting a sale process, we would always recommend taking appropriate advice which would, as a minimum, include an experienced corporate lawyer and in our view (as a potential buyer of businesses) hiring a corporate finance adviser is generally an investment that will more than pay for itself. Your advisers will help ensure the business is presented accurately but in the optimal way to attract interest. They will manage a large part of the process ensuring you have time to continue to focus on the performance of the business, as the last thing you need when trying to sell is a downturn in trading.

Advisers will also plan a process that maximises competitive tension, even if you think there is only one good buyer. It’s important to keep control of the transaction, with competitive tension being the best way to achieve this. Also, a corporate finance adviser will usually be able to review and access overseas buyers as well as companies which you may never have come across or even considered as acquirers. There is a significant amount of inward investment activity, with over one third of buyers of UK businesses between 2009 and 2017 emanating from overseas.

Carefully consider who is being approached as a potential buyer

Very large trade buyers may appear to have the strongest rationale to acquire your business but getting high enough up their agenda for them to prioritise your transaction can be a real struggle. As with all trade buyers they never have to make an acquisition – it is always easier to say no! Competitors present different problems – are they just fishing for information? A carefully managed process can help mitigate this risk and ensure they don’t walk away with your trade secrets.

The other, often overlooked pool of potential buyers for owner-managed businesses are private equity (“PE”) investors. One obvious difference is that it is their business to buy businesses. It’s unusual for them to outbid the most interested trade buyers where there may be significant commercial synergies but private equity can present many benefits for the retiring owner-manager when compared with offers from trade. Introducing private equity buyers into a sale process will, in our opinion, only increase the likelihood of meeting the vendor objectives. It will drive competitive tension without the commercial sensitivities of talking to a broad range of trade buyers and ultimately significantly increasing the chances of delivering a deal.

So why would you consider Private Equity over Trade buyers?

As private equity typically invest in businesses on a standalone basis and don’t have the ability to generate revenue and cost synergies, sellers may be concerned that they won’t achieve the optimal valuation for their company. However vendors rarely find a trade buyer who is both acquisitive and willing to pay the vendor for the synergies they plan to deliver, so this valuation differential is not as common as perceived.

The flip side of this coin is that PE buyers are more likely to preserve the independence of the business and will look to deliver growth, which may lead to better opportunities for staff, as opposed to the risk of redundancy as cost saving exercises are carried out. The legacy of the business and impact on staff are often key concerns for many owner-managers whether their name sits above the door or not. PE can offer exceptional opportunities for the management team going forward, including a share of the equity, as they seek to align themselves with key members of the team. PE can also offer owner-managers the opportunity to stay involved, typically as a Non-Executive Director and retain an investment in their business which is often seen as a win-win for both buyer and vendor.

It’s worth noting that Private Equity comes in all shapes and sizes. There are hundreds of investors in the UK alone, from business ‘angels’ and family offices through to large international PE houses investing in multi-$bn deals. Your advisers will be able guide you to the most suitable based on their investment criteria and approach.

Could Seneca Private Equity buy your business?

Seneca Private Equity looks to invest up to £5 million into SMEs across all sectors, typically generating profits of up to £2 million. We position ourselves as true partners of the management teams we invest in and we will work constructively to deliver growth, ultimately creating value for all parties.

There’s a lot to think about as an owner-manager approaching retirement. If you are looking to realise value from your business, we’re always interested to discuss your plans and help you establish your objectives. We might not be the right investor to buy your business and we might not be the right adviser to help you sell your business but Seneca is entrenched in the SME market. We are always interested to meet business owners and ambitious management teams and we certainly have the tools to help owner-managers navigate the retirement trap!

Please contact us if you’d like to hear more…

Andrew Stubbs – Head of Private Equity
andrew.stubbs@senecapartners.co.uk

Paul Leyland – Investment Director
paul.leyland@senecapartners.co.uk

Important information

This information is of a general nature and does not constitute an offer to provide services.

Any opinions or conclusions attributable to Seneca Partners are based on the understanding of the available information at the time of publication. Such opinions or conclusions are subject to change without notice.

The value of investments and/or any income arising from them may fluctuate.

Past performance is not necessarily a guide to future performance.

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Seneca Partners recommends that any investor seeks specialised financial and/or tax advice before investing. Seneca Partners does not provide advice and the information on this website, including but not limited to news, should not be construed as such.

Please confirm that you understand this warning and wish to proceed.

Risk summary

(Estimated reading time: 2 minutes)

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    • If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
    • Advertised rates of return aren’t guaranteed. This is not a savings account. If the business doesn’t pay you back as agreed, you could earn less money than expected or nothing at all. In addition, if the tenant of the property being financed doesn’t pay the rent due as agreed or vacates the premises, you could earn less money than expected. A higher advertised rate of return means a higher risk of losing your money.
  2. You are unlikely to be protected if something goes wrong
    • Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker at https://www.fscs.org.uk/check/investment-protection-checker/.
    • Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection at https://www.financial-ombudsman.org.uk/consumers.
  3. You won’t get your money back quickly
    • This type of business could face cash-flow problems that delay payments to investors. It could also fail altogether and be unable to repay any of the money owed to you.
    • Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    • Even if you are able to sell your investment early, you may have to pay exit fees or additional charges.
    • The most likely way to get your money back is if the business is bought by another business or is wound
      up following the sale of the underlying property. These events are not common.
    • If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these. This investment aims to make quarterly repayments that comprise both a partial repayment of capital and interest, although this is not guaranteed. It could take over 14 years to receive back an amount equal to the amount you invested.
  4. This is a complex investment
    • This makes it difficult to predict how risky the investment is, but it will most likely be high.
    • You may wish to get financial advice before deciding to invest.
  5. Don’t put all your eggs in one basket
    • Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    • A good rule of thumb is not to invest more than 10% of your money in high-risk investments. (See https://www.fca.org.uk/investsmart/5-questions-ask-you-invest).

If you are interested in learning more about how to protect yourself, visit the FCA’s website at www.fca.org.uk/investsmart

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Risk summary

(Estimated reading time: 2 minutes)

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    • If the business you invest in fails, you are likely to lose 100% of the money you invested.
    • Many of the loans ultimately financed by your investment are made to borrowers who can’t borrow money from traditional lenders such as banks. These borrowers have a higher risk of not paying back their loan.
    • Advertised rates of return aren’t guaranteed. If a borrower doesn’t pay back their loan as agreed, you could earn less money than expected. A higher advertised rate of return means a higher risk of losing your money.
  2. You are unlikely to be protected if something goes wrong
    • Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker at https://www.fscs.org.uk/check/investment-protection-checker/.
    • Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection at https://www.financial-ombudsman.org.uk/consumers.
  3. You won’t get your money back quickly
    • Some of the loans financed by your investment will last for several years. You may need to wait for your money to be returned even if the borrower repays on time.
    • Some Managers may give you the opportunity to sell your investment early through a ‘secondary market’, but there is no guarantee you will be able to find someone willing to buy.
    • Even if your agreement is advertised as affording early access to your money, you will only get your money early if someone else wants to buy your shares or the company in which you are invested has sufficient available capital to buy them from you. If no one wants to buy, it could
      take longer to get your money back.
    • If you are investing for growth, you should not expect to get your money back through dividends as the Service is not designed to pay dividends to investors seeking growth. If you are investing for income, it will take at least 25 years to get your money back purely through dividends.
  4. Don’t put all your eggs in one basket
    • Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    • A good rule of thumb is not to invest more than 10% of your money in high-risk investments. (See https://www.fca.org.uk/investsmart/5-questions-ask-you-invest).
  5. The value of your investment can be reduced
    • The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on the basis on which these new shares are issued.
    • If these new shares have additional rights that your shares don’t have, such as the right to receive a fixed dividend, this could further reduce your chances of getting a return on your investment.

If you are interested in learning more about how to protect yourself, visit the FCA’s website at www.fca.org.uk/investsmart

Risk summary

(Estimated reading time: 2 minutes)

Due to the potential for losses, the Financial Conduct Authority (“FCA”) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    • If a business you invest in fails, you are likely to lose 100% of the money you invested in that business. Most start-up businesses fail. Please see page 14 of the Information Memorandum for an overview of the types of businesses this fund invests in.
  2. You are unlikely to be protected if something goes wrong
    • Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker at https://www.fscs.org.uk/check/investment-protection-checker/.
    • Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection at https://www.financial-ombudsman.org.uk/consumers.
  3. You won’t get your money back quickly
    • Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    • The most likely way to get your money back is if the business is bought by another business or your shares are sold on the Alternative Investment Market. The latter can only occur if there is a willing buyer.
    • If you are investing in a start-up or EIS qualifying business, you should not expect to get your money back through dividends. Such businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    • Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    • A good rule of thumb is not to invest more than 10% of your money in high-risk investments. (See https://www.fca.org.uk/investsmart/5-questions-ask-you-invest).
  5. The value of your investment can be reduced
    • The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    • These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

If you are interested in learning more about how to protect yourself, visit the FCA’s website at www.fca.org.uk/investsmart

Risk summary

(Estimated reading time: 2 minutes)

Due to the potential for losses, the Financial Conduct Authority (“FCA”) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    • If a business you invest in fails, you are likely to lose 100% of the money you invested in that business. Most start-up businesses fail. Please see page 14 of the Information Memorandum for an overview of the types of businesses this fund invests in.
  2. You are unlikely to be protected if something goes wrong
    • Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker at https://www.fscs.org.uk/check/investment-protection-checker/.
    • Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection at https://www.financial-ombudsman.org.uk/consumers.
  3. You won’t get your money back quickly
    • Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    • For companies whose shares are not listed on any exchange (‘unquoted’ or ‘private’ companies), the most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
    • For companies whose shares are listed on an exchange (such as the AQSE or AIM), the most likely way to get your money back is if the business is bought by another business or your shares are sold on that exchange. The latter can only occur if there is a willing buyer.
    • If you are investing in a start-up or EIS qualifying business, you should not expect to get your money back through dividends. Such businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    • Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    • A good rule of thumb is not to invest more than 10% of your money in high-risk investments. (See https://www.fca.org.uk/investsmart/5-questions-ask-you-invest).
  5. The value of your investment can be reduced
    • The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    • These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

If you are interested in learning more about how to protect yourself, visit the FCA’s website at www.fca.org.uk/investsmart