Sow wisely for business success - Part 2: Growing a business beyond the start up phase
In the second of three articles examining how to grow a successful business by minimising your tax liabilities, Lesley Stalker, Paul Webb and Simon Patterson, partners at the Robert James Partnership, advise on how to develop beyond the start up phase.
As a start up enterprise, you have probably enjoyed initial success because of your own skills in a particular area. Essentially, your customers are very likely to have bought into you as the business owner. This is invaluable when initially setting up, but looking to the future, it is vitally important that the business is not reliant on just one or two people (usually the founders) if you are thinking of selling as an exit.
As an owner-manager one of the most common traps you can fall into is being too self-reliant. To external eyes this would suggest you have an inadequate management structure and have problems delegating. You need to ensure that to an outside investor, your business will look a viable going concern even if you are no longer involved operationally. So, one of the most important strategies for successful growth is to implement the right management structure for your business type.
Having a good management team in place will enable you to focus on aspects like business development, confident in the knowledge that there are professionals employed to take care of the day to day. In addition, appointing a non-executive director - an individual with previous experience of developing and selling a business - to work along side you is also a very useful strategy. This person needs to be able to give you objective advice. The role could be performed by an accountant, provided they have sufficient business development experience.
Keep a lid on dividend withdrawals
The second thing you need to consider is what state are your financial and management accounts in? How would they look to an external investor? Ask yourself the following questions:
- Can you demonstrate a healthy growth year on year?
- Can you show where profits have been re-invested in the company to support further growth?
- Are there likely to be questions asked because of the way you have withdrawn money from the business?
When grooming a business for growth before an eventual sale, this is a key consideration, and a careful balance needs to be made between continuing to withdraw dividends or bonuses – especially if this forms a key part of your remuneration as a director – and how this might be perceived by prospective buyers. Our advice would be to continue taking dividends, but set strict limits and stick to them. And whilst it is important to minimise tax liability, we would suggest you consider minimising taking out funds as bonuses as this will impact your profit levels adversely whereas dividend withdrawals impact the accounts post profits..
Spread the risk of losing customers
As well as ensuring the business is not reliant upon one or two key individuals, it is also important to be able to demonstrate that if the business were to lose a few customers for whatever reason, this would not have too significant an effect on future growth. A good strategy would be to have a wide range of customers of different sizes, i.e. a larger number of smaller customers as well as some bigger clients, to cushion the impact of potential losses.
Make sure you hold onto key employees
When you sell your business, especially as a large proportion of businesses today are service oriented, the new owners are essentially buying the goodwill and expertise of your employees; the goodwill and loyalty of your customer base; and the equity within your company’s brand identity.
A strategy for holding onto key employees is crucial to the future valuation of your business and potential investors will look for ways they have been incentivised to stay in the longer term. A highly tax efficient way to effectively "lock in" employees is to offer the option to buy shares in your business as part of an Employee Management Incentives (EMI) scheme. This was first introduced by the government to help 'small, higher risk' companies recruit and retain 'key' individuals to help their businesses succeed and grow, by offering tax-advantaged share options, and has proved a highly effective way to attract, motivate and retain staff.
Identify the critical employees and communicate their role
However for EMI schemes to really work for a company, two key criteria need to be met. Firstly as a business owner you need to make sure you give options to the right people, the ones who are really crucial to the financial success of the business, and not just award options to long standing or "loyal" employees. The latter might have been with you for a long time, but they may not be performing well, and offering options could result in them staying put just to realise their eventual windfalls. It is easy to be overly generous with share options when your company is starting out and worth very little, but this can change very quickly.
Consider the following scenario: if your business is worth £1m and you offer employees the option to buy 10% of the shares in your company, you are effectively giving them £100,000 from your own pocket. If the value of the company rises to £10m by the time the options can be exercised, 10% in share options would mean you are giving away £1m. In this case you would also be gaining a lot more as the majority shareholder, and theoretically employees would have made a major contribution to building your £10m business and earned this windfall. But, if you award options to everyone, you will also be giving value away to those who have not necessarily contributed to building it, whilst restricting the growth in value which is available to those who have.
The costs of EMI schemes to the business owner occur in the long term, and it is far better to give non-key but loyal employees a bonus and reserve share options for the people that really contribute to growth and profitability. Share option schemes are also a good option if you think you may be able to secure an exit via a management buy out (MBO), and a great way of helping employees to raise the necessary investment capital.
The second criterion that needs to be met for EMI schemes to be effective as employee motivators are related to communication. Often the reason why companies with EMI schemes in place which are not the motivational tools they should be, is that they have been poorly understood and communicated to employees. Qualifying employees need to fully understand the benefits and huge opportunity they present. It is vital that they fully understand the so-called "bigger picture"; that they know why your business is following a particular strategy, what its longer term plans and forecast growth projections are; when these figures been achieved and their role in helping to achieve them. Whilst senior management will all have access to this information, other critical employees may be included in EMI schemes but are not privy to such strategic information. All qualifying employees need to understand how they contribute to the business and specifically what they need to do to achieve strategic objectives for share options to work as a motivator.
Role play with your accountant
Finally, if you think an eventual sale would be the most desirable exit strategy, it is always prudent to conduct regular mock due diligence exercises as part of a role play with your existing accountants. When an investor evaluates your business, they will undertake the process of due diligence, during which they scrutinise every aspect of the financial management of the company, looking for possible future problems.
Your accountants can help you identify any issues that would need resolving well before any approaches from investors and work on these whilst there is still plenty of time available. If you want to grow your business, think of your accountant as a highly experienced business advisor, someone who is exposed to a huge variety of other business strategies, who can lend an objective eye and provide a much needed sounding board for your ideas and ambitions.
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BusinessZONE - 14-Jun-2007
Categories: Tax, Money matters
Story read: 2863
Number of comments: 2
Part one
Dan Martin, 25 June 2007 @ 12:05 PM
The link above to part one is now working. You can also access it by clicking here.
Dan Martin
Editor, BusinessZone
editor@businesszone.co.uk
Part 1
David Burdon, 25 June 2007 @ 11:10 AM
I'm looking for part 1. The link is not currently working - 24th June 07.
