Succession Planning: 58% of UK SMEs not realising their true value

58 per cent of family-run businesses in the UK have not done any form of succession planning in place according to Legal & General. Without wishing to drag tired clichés up already, handing over your business to the next generation or a third party is a case of “fail to prepare and prepare to fail”.

As a small business accountant, our opinion is if you wake up one morning and decide you want to retire you should have started succession planning for it 3 years before to avoid potentially reducing the value you receive for what may be your biggest asset.

Small and family businesses have played an important role in Britain’s economy across the generations, comprising the backbone of the country’s economy. However, these figures show many of them are completely unprepared for the transfer of ownership from one generation to the next and are missing out on unlocking the true value of the business they created.

What makes a business valuable?

The purchase of a business in its simplest form is the acquisition of an asset that yields a return. In much the same way as investing in a government bond provides an interest return, or buying a buy-to-let property provides a rental yield, investing in a company provides a dividend return.

How much a buyer is willing to spend to acquire the rights to the dividends of the company is based on many factors, some of which are outlined below:

(i) Stability and scale

Clear and accurate financials accurately tied to tax returns add value to a business. Overlooked by many, this one is really key. Financial records prove your stability to a potential buyer and adds true value to your company’s price tag.

Additionally, a good set of financial records can lead to quickly identifying how scalable the respective business is. If the accounts show that the businesses revenues are growing at a faster rate than is operating costs, then that business scales and has the potential to grow even more into the future, thus being regarded as a valuable business.

(ii) Predictability of revenue

Predictable revenue is the portion of a company's revenue that is highly likely to continue in the future. It is revenue or income that recurs, is stable and can be counted on in the future with a high degree of certainty.

For example, a digital marketing agency that has a range of customers on contracts of one, two or three years have secured themselves a sizeable chunk of predictable revenue.

(iii) Diversification

Too many businesses, particularly consulting firms, rely on revenue streams from too few clients — something that would make a new owner vulnerable if those relationships were the result of connections to the original owner.

Companies should work to ensure that they have broad enough customer bases where if any single client or vendor were lost the business could still thrive.

If one customer accounts for 20 to 25 percent of revenues, it’s a problem, and if a single client is responsible for more than 40 percent of sales, it will seriously undermine the likelihood of a sale.

(iv) Profitability

Concentrate on building your business so that it delivers three years of healthy profits in excess of 25% per annum. Without profit it is going to be virtually impossible to sell your business.

The preservation of cash in the business is also pivotal in impressing a buyer during the due diligence stage.

Therefore, try and ensure that in the run-up to the sale you have conserved money and that your cash flow is strong.

(v) Quality of staff

A lot of businesses aren’t appealing to buyers because too much of their value is tied up in the owner’s work. Smart owners should consider a succession plan so that the business has leaders after the owner leaves.

If the business cannot run effectively day-to-day without the owner, then it has no real value to buyers.

Business owners should ask themselves if they can take a month’s holiday and expect the operation to be humming when they return. If the answer is no, the company needs to develop new leaders.

(vi) Timing

Timing is important. During periods of strong economic growth, such as the years immediately prior to 2007, timing an exit was more or less irrelevant because the values of businesses in general were continually rising.

We are not yet back in such heady times so it is important to try and align the timing of the sale of your business to hot trends within your sector in this nascent upturn and position your revenue streams as coming from the most exciting areas.

For example, many publishers are now recasting some of their revenues as coming from ‘digital’ while tech companies are looking to characterise portions of their revenue as coming from cloud-based services.

Of course selling in an upturn should deliver a strong value, but proper planning and positioning ahead of exit can ensure you secure the maximum price your business deserves.

Why is succession planning important?

It is highly unlikely that any small business is fully optimised with regards to the above list of what makes a business valuable. Value comes with time and planning, with a particular focus on significantly strengthening the company’s weaker areas.

Making a business distinct from the owner does not happen overnight. For potential buyers, they want proof of the ability of the owner to step away, but for the day-to-day operation and success of the business to continue, independent of the owner.

As stated above, owners should have a three-year plan where the business’ independent performance is shown consistently over that period. This gives the company a history of not relying on the owner to succeed.

Additionally, if companies are to create meaningful relationships that can outlast one customer service hiccup or even a change in ownership, they need to start doing things with a long-term view.

The same long-termism must apply to the development of systems and controls. Every organisation has controls no matter how unstructured it may seem. The absence of documented controls does not mean they do not exist. However,it is key that time is dedicated to honing these systems and optimising the efficiency of the business.

How does succession planning dictate business valuation?

The average small business in the UK is value at £90,000, according to BizDaq, and while this obviously varies based on the industry in which a company operates, the first thing that stand out is how much growth could potentially be tapped into when it comes to this average value.

Let’s use the example of a website developer based outside any of the major UK cities. This type of business will generally have certain common characteristics that are valuable to potential buyers, but the potential sell of the business will often be overlooked by the business owners themselves as they don’t realise the potential value they could capitalise on.

For one, they will have a client base who generally rely on that developer for upgrading their website, routine performance checks etc. - this implies recurring income and creates a vital arm of the business.

Secondly, there is a portfolio of new relationships available to a potential buyer. In an age where business leads are fought for tooth and nail by competing businesses, the opportunity to acquire a database of new clients is a valuable asset for any small business looking to sell.

Succession planning protects a business’ performance from suffering when one of the key people leaves. Adopting these simple approaches will help your business to become more successful, and, ultimately more valuable should the company ever be sold.

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