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A solution to succession planning in a family-owned business in the agricultural and rural business sector could be a sale of the business by the senior generation to the next generation of family members.
This is commonly referred to as a family business buy-out or FBO.
This structure is similar to a management buy-out except that instead of the management team being the buyer, it is the next generation of family members.
It is not always the case that the family business passes to the next generation by way of a gift.
It is not uncommon for the next generation to purchase the family business from their parents.
Reasons for an FBO
There are many reasons why an FBO may be appropriate, for example:
- There could be insufficient pensions or other investments for the senior generation to live off of in retirement. In other words, the parents will not have sufficient means for their retirement if they give the business away;
- To address the question of fairness within the family. The family may wish to adopt a business-first approach, whereby ownership of the family business passes to those next-generation family members working in the business. However, the senior generation might wish to achieve fairness in order that family members not working in the business receive a larger share of assets held outside the family business. Even if the senior generation are adequately provided for in their own lifetime, they might not be confident that there will be sufficient surplus assets on their death to achieve this. Therefore, the sale of the business by way of FBO may achieve fairness in the longer term as those family members not involved in the business may revive a more equitable inheritance from the senior generation;
- It might be thought necessary as a matter of pride and self-worth for the next generation to pay something for the business rather than having this “handed to them on a plate”. If this is the case, these aspects will need to be discussed in detail between the generations. Conversely, it might be the view of the senior generation that the value they have created during their working lives should be formally recognised by the purchase price paid for the family business.
Price
The price adopted could be anywhere on a scale, from the price paid by a third-party purchaser to a relatively nominal amount.
It is not unusual for the terms of the FBO to be somewhere in the middle of this scale.
Affordability will need to be considered. It may simply be beyond the means of the next generation to afford or finance an FBO at full market value.
This may not be necessary if the primary consideration is limited to providing the senior generation with adequate means in their retirement.
It can be more difficult to structure an FBO to achieve fairness in the sense of equality between those family members working in the business and those who do not if the market value is not paid to the senior generation.
It may also be difficult to arrive at a price that is fair to family members working in the business if their pre-succession contribution is taken into account.
In many circumstances, a combination of planning, communication, and compromise is necessary.
Practical steps that can be taken include a careful analysis of the financial needs of the senior generation in retirement, a professional valuation of the family business should, in most circumstances, be carried out and engaging outside consultants to establish the views and priorities of different members of the family can also be helpful.
Types of payment structures for FBOs
There are various types of payment structures that the FBO could adopt, for example:
- The FBO could be financed by a third-party commercial lender, whereby a loan is taken out by the family company. There might be a reluctance to go down this route as the introduction of heavy gearing might be against the conservative instincts of the business-owning family, particularly if, say, a farm has been owned by a family for generations. It may also be the case that the business might simply not be able to obtain mainstream commercial bank lending;
- The next generation could borrow the funds, perhaps supported by a re-mortgage of their home. This type of arrangement could be to support company borrowing or instead of it. It may be thought appropriate for the next generation to take some personal risk to demonstrate their commitment. The next generation may argue that they have already made a considerable personal sacrifice in dedicating their careers to the family business;
- The purchase price could be paid on deferred terms and financed from the future cash flow of the family business. The deferred payments could be fixed amounts payable on certain dates, or the amount of the payments could be linked to the performance of the business. The payments could be simply contractual under the sale agreement or structured in the form of loan notes (i.e. debt securities);
- If the company has sufficient distributable reserves, the senior generation could be bought out by a company share buy-back. Alternatively, where there are surplus funds in the target company, a new company could be established as the buying vehicle, which could utilise those surplus funds as part of the purchase price with the balance of the price paid on deferred terms. These structures have the advantage of the company financing the buy-out and not individual family members/shareholders;
- It may be appropriate to consider more radical restructuring of the family business to free up funds. For example, a non-core business or business premises/farming land could be sold to raise funds;
- A hybrid ownership solution could be adopted, whereby the senior generation retains a residual interest in the family business, with the next generation taking a controlling interest. To a certain extent, this could have the advantage of managing the purchase price to be paid to the senior generation and could allow the senior generation to receive income via dividends.
Conclusion
In practical terms, there is no “one size fits all” structure for an FBO.
The structure of an FBO will need to be tailored to suit the specific circumstances of the business and the family members.
The solution may well involve a combination of the elements highlighted above or other arrangements.
If you are considering the FBO route, we would certainly recommend that professional advice be obtained from an early stage.
The Agricultural and Landed Estates sector group at Myerson draws on specialists from across the firm (including corporate, commercial, real estate, trusts and probate, employment, family and litigation (including commercial, probate and real estate) to provide joined-up solutions for our clients.