As a business owner, whether founder or partner who has risen through the ranks, the focus throughout one’s working life is on building and maintaining a successful and profitable business. When thoughts of retirement first emerge, questions about succession planning come to the fore.
Outgoing directors need to work out an arrangement that suits their practice and set their plans in motion over several years, well before the planned retirement date. Unless an outright sale is on the cards, the challenge is to find a way of extracting reasonable value without harming the business.
Favourable tax legislation introduced in the Finance Act 2014 has made Employee Ownership Trusts (EOT) a popular option for many architecture practices in recent years. However, this solution may not fit all businesses, so how are others solving the succession question?
One director of a London-based practice that is a few years into a succession plan with some time to run, explains how they had to look for an ownership transfer route that would be acceptable, and achievable, for outgoing and incoming directors.
The practice is profitable, works across a variety of sectors, and with more than fifty staff is a substantial business to hand over.
‘Our original idea was to sell the company. Thoughts at the time were of an overseas buyer, perhaps from the US or Canada, looking to enter the UK. It can work if you meet the right people at the right time, but after talking to some potential buyers, they appeared more interested in stripping out value than investing in the business,’ this director recalls.
‘We decided then that we would look at bringing people on with the aim of allowing them to buy shares in the business.’
Company valuations are one thing, realising that value is quite another. The practice has a handful of outgoing directors who will all be exiting and handing over to a similar number of internally promoted directors, who, as one might expect, were not in a position to buy the company outright.
Had the owners decided to offer a generous rebate on their shares, this could have left the new directors facing a very large tax bill for receiving ‘benefits in kind’.
‘We had to strike a balance so that the shares were more affordable to the incoming directors, but not so generous as to appear unreasonably cheap.’
The total amounts to be taken out by the outgoing directors and invested by the new directors had been agreed in the succession plan from the outset.
Taxation emerged as a key part of the equation for both the old and new directors. After taking specialist advice, a formula was developed that would allow the outgoing directors to maximise non-taxable dividends and company contributions to their directors’ pension funds, the pension top-ups being by far the most valuable.
Pension top-ups are attractive because a significant sum can be built up over a multi-year succession period, with the additional flexibility of back dating top-ups three financial years.
Arrangements were made on the basis that the company would continue to break even after dividends and pension contributions had been paid, with options to speed up or slow down the process during the succession period to take account of company performance. In the event, the practice has managed to stick to its payments plan.
At present, new and outgoing directors all have an equal shareholding in the practice. In the near future, the outgoing directors plan to sell their remaining shares to the new directors and to complete the handover.
There is a possibility of former directors continuing to be involved with the business in some way, perhaps on a consultancy basis, but there is no provision for this in the plan and all parties are agreed that any such decisions will be taken by the new directors.
‘There has always been a plan and a spread sheet for the handover, but one of the key elements in the arrangement was an informal understanding that the plan could adapt and change if necessary, and everybody was happy with that. That, of course, does require a certain degree of trust,’ the director adds.
Text by Neal Morris. This is a Professional Feature edited by the RIBA Practice team. Send us your feedback and ideas
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Posted on 26 April 2018.
