Succession Planning: handing over the reins – Published in the AIMA Journal – Edition 136
The effective leadership of a business is paramount to its success and strategic direction. Succession planning ensures continuity of leadership and owners should plan succession well ahead of time to protect the business. Planning involves time and effort from owners, senior management, professional advisors and investors.
The hedge fund industry has grown rapidly in the past couple of decades. Managers who have been in operation from the beginning of this period may now find themselves in the mature phase of their life cycle needing to consider options and planning to pass on leadership roles. Hedge Fund managers often have a ‘keyman’, who is typically the founder / owner, and their name is usually attached to the business. When the ‘keyman’ eventually retires, continuity (and survival) depends on a smooth succession process. This article highlights some planning options available to owner / managers and key considerations for each option. The comments in this article are general in nature and not intended to be advice.
Passing to family – a “simple” option is to pass ownership to children / spouse or other family. This option may be beneficial from a tax perspective, with potential reliefs and exemptions for both Capital Gains Tax (CGT) and Inheritance Tax (IHT) – conditions apply. However, the unique nature of the asset management business, requires the successor to have the relevant skills, technical knowledge and experience to carry on the leadership role. Alternatively, the successor family member may choose to retain ownership and appoint another individual to the management role. In either situation, the outgoing owner may hold a non-executive or advisory role after retirement to ensure a smooth transition.
Third party sale – the owner may sell to an external third party. For a successful business that can negotiate a fair price, this option could yield the maximum value. The sale of the business will be subject to CGT and any reliefs will have to be considered. Asset management businesses tend to have internally generated goodwill that is not on their balance sheet as an asset. Asset managers are a people business and their ability to generate income is linked to the individuals in the business, who are the key assets. A buyer is likely to retain key individuals to retain the brand value. The cost of this may be reflected in the price and it is likely that the owner can only step away gradually.
Rather than selling the business outright, a buyer partly invests in the business, and the existing owners dilute their holding over time.
Management Buy-Out (MBO) – here the management of the business buy the business. Whilst this could be an ideal option for an owner to secure the future of the business, it depends on the ability and willingness of the management team to take on the pressure and responsibility that comes with ownership, the unity of the management team and their ability to agree a realistic price with the owner. Private equity and debt are common ways that MBOs are funded. Other options include employee ownership trusts (“EOT”) (which could result in a tax-free sale) or awarding employees with incentive share options during their time in the business.
Having management personnel take over the business, may provide peace of mind to the owner and make their exit smooth in terms of handing over the business and keeping the legacy intact. The owner may be able to step away from the business sooner and may feel more comfortable with the management already knowing the business well and providing continuity.
The tax implications under this option will depend on how it is structured. Employees must consider the Employment Related Securities rules and the owner likely being subject to CGT, unless selling to an EOT.
Bringing in new talent – the owner may bring in new talent to take the business forward with a view to preparing them for future leadership. Planning for this usually starts well in advance as finding the appropriate person to bring into the business can be a lengthy process. More commonly, owners’ mentor someone within their business with a view to promoting them and taking over the business once they eventually step down.
The owner may retain ownership of all or part of the business to later pass down to family, to a third party or new management in due course. The tax implications under this option would depend on the course of action taken.
Voluntary liquidation – where the owners do not want to run the business anymore and it is not viable to pass on the ownership to family members or third parties, it may be preferable to voluntarily liquidate the business. The assets and liabilities of the business are reviewed for this process to make a declaration of solvency stating that the company is able to pay its debts. This is followed by the shareholders passing a resolution for voluntary winding up and appointing a liquidator to complete winding down process, settling liabilities and distributing remaining assets to the owners. The tax implications of this option would depend on the tax profile of the individual shareholders / owners, the structure of the business and the availability of reliefs.
Going public – a less common option is to take the business public and make it a publicly traded and owned entity. Whilst this option is usually considered when raising capital for the business, it can also serve as an exit strategy allowing the owner to realise part or all of the value they have built up in the business. To be viable, the business requires a strong management team with a track record of strong performance to attract public investors with a sufficient return on investment. There are significant costs associated with the floatation process along with legal, accounting, and regulatory considerations that makes this option more time-consuming and expensive than others. There are also further considerations relating to the choice of stock exchange, valuation of the business and other administrative and statutory burdens that may dissuade owners from pursuing this option despite the ease of raising capital and increasing the company profile.
Further considerations
It is important to document provisions relating to leaving, disposal, winding up, dissolution, etc. in a business’s constitutional documentation / shareholders agreement / partnership agreement as appropriate and have a clear path to follow when any such event occurs. Businesses may also choose to have a buy-sell agreement in place stipulating what will happen with the business if something were to happen to the owner / owners and providing limitations on how the owners can transfer or sell their stake in the business. Having documentation in place at the outset ensures certainty towards the future of the business when an owner chooses to retire or there is an unexpected event such as disability or death and provides reassurance to stakeholders in these circumstances.
Tax is a key area to be borne in mind when considering the exit strategy for a business. When passing down the ownership of a business to family, it is important to consider whether the conditions for gift holdover relief are met to defer any CGT charge until the shares are ultimately sold. Another vital consideration upon the sale of a business is the availability of business asset disposal relief (previously known as entrepreneur’s relief), that reduces the CGT charge to 10%, subject to conditions and limits. For IHT purposes, the timing of passing down shares to family needs to be borne in mind. There may be no charge if Business Relief applies, or the donor survives for 7 years following gifting the shares. It is also possible to use a trust structure to protect assets for beneficiaries. Consideration should also be given to the different tax implications for a partnership vs a corporate structure.
The exit considerations will ultimately be dependent on the type of structure used by the business and may significantly change the succession planning options available to the owners. Given the complexity of legislation applicable to different structures, the tax implications for each case need to be considered in detail and professional advice needs to be sought based on the specific facts and circumstances.
Whilst several succession planning options may be available to asset managers, the preferred course of action will depend on their individual needs or circumstances and take into account both personal and commercial factors. A well-planned exit strategy will also entail detailed consideration from a tax, accounting and legal perspective whilst ensuring the maximisation of wealth to the owners / future generations and keeping the legacy intact where intended. Finally, it is important to note that it is never too early to start the succession planning process as it may take equally long to be able to exit a business as it took to build it.