Business Adviser Summer 2008 Issue 35 How to exit your business well Is there ever a right time to prepare your business for sale? Some might say the right time is right from Day 1 of owning it. But you are more likely to think about exit strategies at a certain stage of life. If sale is on your horizon, the current market environment is as good a time as any to act. One positive of the current economy is that if business growth has stalled, the reasons can be fairly easily explained to potential buyers. There are other aspects of this market that can work to your advantage too. This maybe the ideal time to acquire market share, to provide a stronger competitive position. You may find the staff you need to take you to a new level. You may be able to clear some assets to provide greater focus on other core parts of the business, or pursue a new opportunity. So the first consideration in planning for sale is not to make assumptions about the market conditions and when is the “best time”. It is more important to consider who will be the ideal purchaser and how will you position your business to be as attractive as possible to them. Other considerations include: What influences the value? The normal basis for purchase is a multiple of maintainable profits, so ideally you want to groom your business to show a solid, and preferably growing, earnings stream. That might mean: • Signing a long-term contract with a key customer. • Implementing a marketing strategy that will drive the business forward. • Getting some key staff in place. • Making a strategic acquisition that provides a point of difference in product or service mix. The better the business looks in terms of growth and profitability, the higher the multiples it will achieve for the industry it is in. The purchaser’s main considerations will include: • • • • • • Cash generation. Quality of financial data. Certainty of future earnings. Sector and market position. Potential liabilities. Synergies. Different types of purchasers present advantages and disadvantages. A competitor has the advantage of synergistic pricing, and speed, but presents issues with confidentiality. A purchaser involved in related activities may be prepared to pay a premium, but have limited understanding of your industry. A private-equity buyer can be considered ‘reliable’, but may be slower to make a decision, and prefer an exclusive position for a period of time. An MBO may require fewer warranties, but also may need finance. Continued page 2 Who are the buyers? Normally, there are key organisations that have a special interest in buying the business. For instance, a startup biotech firm that has developed a new technology will be of most interest to a pharmaceutical company. A large beverage manufacturer undoubtedly has an interest in a successful “boutique” drink. There are also the options of corporate investment, and management buyout (MBO). Contents 01 How to exit your business well 02 A business-friendly government? 03 Avoiding family business disaster Annual questionnaires go online 04 The bottom line of Christmas spirit Office hours over Christmas 1 How to exit your business well (continued from page 1) The optimal purchaser is one who is willing to pay a premium, who accepts the business “as is”, and presents no conflicts of interest or regulatory issues. Financial aspects Depending on the timeframe you have for the sale, you should act to: • Maximise maintainable profits. • Reduce costs (but sometimes you need to spend to create options for purchasers). • Manage working capital. • Review and dispose of surplus assets. • Rationalise suppliers and customers, to ensure there is no over reliance. • Ensure there is a strong management team in place, that is separated from the ownership of the business. Legal and operational aspects Fundamentally, you are either selling shares or assets. It is important to ensure that legally, these can be handed over to a new owner. • How feasible is it to transfer contracts? • Are there any contingent liabilities that will make it difficult to sell the shares (or lower the price)? • Is there any pending litigation that needs to be settled? • Are all legal documents such as leases and employment contracts up to date? Operationally, you need to make sure that the business can function under a new owner. This may require consideration of the impacts on an employee share scheme, or there may be third-party assets that cannot be transferred, but that would affect the running of the business. It’s also important to: • Set out strategy. • Resolve tax issues. • Simplify and document systems. The sales process Whether the sale is managed by auction, general or targeted marketing, it’s important that potential purchasers are aware that a competitive process is in place, including a timeline and that the process is professionally run. A rigorous process also creates confidence and a more certain outcome for both vendor and purchaser. This process is built through: • Initial proposals. • Due diligence. • The offer. • The final documentation. If a purchaser considers the process is being poorly managed, they are unlikely to invest time to assess the business. For further advice, please contact your Grant Thornton adviser. A business-friendly government? It is now time to see if National will fulfill its promise to let small business “get on with running their businesses”, as its campaign slogan promised. It has begun boldly, in quickly passing legislation covering new tax rates and a 90-day probationary period for new employees in small businesses (fewer than 20 employees). Pam Newlove, director of Grant Thornton’s Business Advisory Services, says the drop in the company tax rate from 33 to 30 percent in April this year by the previous government will have limited benefits for most business owners. “This is because any profits taken out of the company and given to shareholders will ultimately be taxed at the marginal tax rate of the shareholder. For most businesses, trusts hold most of the shares in the company, and the trust tax rate is 33 percent.” The personal tax cuts announced in mid December should deliver a small boost to the economy, she says. While most 2 rates remain unchanged from 1 April 2009, the top rate for incomes of $70,000 or more has been reduced from 39 percent to 38 percent, and will reduce to 37 percent in April 2010. A cut from 21 percent to 20 percent for income earners in the $14,001-$50,000 bracket takes effect from 1 April 2011. The Government has also announced changes to Kiwisaver that will see the minimum rate reduce from four percent to two percent, and two percent will be the default contribution rate from 1 April 2009 for new employees. Employer contributions will be capped at two percent, but the employer tax credit will be discontinued from 1 April 2009. The employer superannuation contribution tax exemption will be capped at two percent, which means that any employer contributions over two percent will be subject to ESCT at 33 percent. As well as the above changes, an ‘Independent Earner Credit’ has been introduced for people who earn $24,000 a year or more and who are not receiving a benefit, Working for Families payments, or New Zealand Superannuation. This amounts to a rebate of $10 per week from 1 April 2009, and $15 per week from 1 April 2010. Obviously this will create some extra compliance costs in that some new PAYE codes will be required, though this is not expected to be too onerous. But Ms Newlove suggests the government must concentrate on further measures that don’t add to the very real burden of compliance costs for small businesses. National’s plan to provide choice for accident insurance in the workplace has benefits to “pockets of business owners”, she says. “But the changes must be done properly.” Avoiding family business disaster reviews of family members who hold senior executive positions. The business as personal piggy bank Family businesses make up more than two out of three companies worldwide, and employ more than half the industrialised workforce. Equally significant, less than a third of family businesses survive to the next generation, according to Grant Thornton research. What are the peculiarities of family businesses that create such a high level of attrition? Here are some of the common mistakes. The ‘Royal Family’ Succession plan Promotion of the eldest child, regardless of skills, market appeal or interest in the business is not recommended. Choose your successor based on their ability and skill in business. The mortgage-based remuneration policy Paying family employees at levels commensurate with their mortgage, rather than their skills, is a waste of money. It can also be de-motivating for non-family employees in similar roles. Take care also to avoid the ‘overpaid and spoilt’ or ‘underpaid and resentful’ traps. The ‘happy family’ performance review It can be hard to be objective about family members. Too often your view of their performance will be impaired due to the family relationship. To get around this, outsource the role of performance Some family businesses are characterised by a blurring of personal and business money management – fuzzy approval of personal expenses, ad hoc compensation payments, and one-off personal cash injections to ‘get by’. Ensure your family member compensation is via payroll, that independent approval is required for personal expenses, and that loans are properly documented. The caged animal syndrome It is quite common for adult children to reluctantly continue their employment in the family business, when they would prefer to work elsewhere. Confirm, annually, that family members are enjoying the role and want to continue their involvement. In addition, there is merit in having them gain experience working in other organisations. Inter-generational misfortunes Often business owners leave their wealth tied up in their business. It makes sense up to a point – the business needs capital to grow, and with the input of a committed business owner, the returns are high. But even the most stable of businesses can go through periods of uncertainty, increased competition, litigation or misadventure. Therefore it pays to build an income stream away from the family business over your lifetime. In addition, succession to the next generation is often more successful when you are not reliant on the business to provide an income for you in retirement. run, who should be employed and how much they are paid. But running your family business as a democracy is the fast route to divorce and bankruptcy. All family members should be considered in relation to three roles: employee, management and owner. They should be paid for the work they do and behave and be treated like other staff. Keeping non-family members in the doghouse As the business grows, outside talent is a must. Make sure that non-family members are included, and have clarity on their rights, career development and rewards. Acknowledge the contribution and effort from non-family employees, especially at senior management level, through participation in planning, management, bonuses and incentives. Governance group think Dependent on the size of the family business, involve non-family members as independent directors to provide objectivity on performance. Soft financial structures and reporting Managing a family business is not like balancing your chequebook in front of the TV. Systematic collation and sharing of management information with the right people is critical. For further information, please contact your Grant Thornton adviser. Democracy - the fast route to disaster Spouses, children, children’s spouses, ex-spouses, grandparents – all can have a view on how a business should be Complete annual questionnaires online We are pleased to advise that from March 2009, our annual client information questionnaires will be available for completion on our website via secure access. This will enable clients to enter annual information questionnaire responses electronically. We will contact you closer to March advising of access passwords and other information required to complete this process online. For those clients who wish to complete these questionnaires manually, that option will still be available. 3 The bottom line of Christmas spirit ‘Tis the season for Christmas parties, gifts and entertainment, and while not wishing to dampen the Christmas spirit, the tax consequences of festive spending should not be forgotten. Christmas expenses fall into three categories when it comes to tax. Understanding the impositions at each tier will help you avoid any unexpected New Year surprises. Fully deductible (and not subject to FBT) • • • • • • • Meals while travelling on business. Food/drink at a conference or training course that runs for longer than four hours. Meal allowance for overtime. Morning and afternoon tea. Promotions open to the public. If an employee’s salary package includes a taxable allowance for entertaining clients. Entertainment overseas. Some specific examples of fully deductible (and not subject to FBT) expenditure are: • Staff morning teas/afternoon teas. • Team building conference (not including spouses). • Sponsorship of external sports team (classified as advertising and requires some link to the business). Fully deductible (but subject to FBT) Any type of entertainment -related expense that is liable for FBT is fully deductible (as is the FBT itself). Some specific examples of fully deductible expenditure subject to FBT are: • Gifts other than food and beverages to employees (most things will fall into this category). • Restaurant vouchers able to be used at the employee’s discretion. • Movie tickets able to be used at the employee’s discretion. If you require further information on any of these topics or would like details on other accounting matters, contact your local Grant Thornton office: These fall into the “Other benefits“ category and will necessitate an FBT return and payment. Spending on “other benefits” otherwise subject to FBT will be exempt from FBT if it is under $200 per employee per quarter or less than $15,000 for the employer for the last four quarters, including the current quarter. 50% deductible (and no FBT) These expenses are only 50% deductible: • Entertainment incurred in relation to an existing or prospective business contact or client. • Entertainment of staff to maintain goodwill. Some examples are: • Staff Christmas party. • Christmas lunch/dinner for colleagues/referral sources. • Food and wine provided to colleagues and referral sources. • Gifts of food or wine to staff (if not subject to FBT). • Food and drink provided for a function on business premises. Please contact your Grant Thornton adviser if you have further questions. 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