Handing over the baton

Of the 5,000 independent intermediaries in the UK broking sector, some 75% have no successor within their businesses. Much has been written about the ageing time bomb and the inevitable huge reduction in the industry over the next ten years, but what about those where there is a successor and there is an understanding that he/she will eventually take over the business when the principal or controlling directors want to retire? Is this a practical solution and what are the issues facing the business if there is to be successful and smooth management buyout (MBO) in the years ahead?

The MBO approach is certainly not as easy as it seems and the best-made plans can falter leaving principals and staff disappointed and having to seek alternative options. It can result in tensions and differing agendas. These can severely affect the business and its ability to take advantage of the opportunities available to ambitious brokers in the coming period of consolidation.

The major stumbling blocks are often the aspirations of the principals to realise the value of the business as a means of funding retirement, and the ability and wish of the successors to fund the buyout.

The value of the business to the principal is easily determined. It is likely to be 1-1.5 times the commission of the business, plus any free assets such as cash and property owned. A business with a commission income of £1m is likely to be worth between £1m and £1.5m to the retiring directors. In current times a good quality commercial bias broker could attain this amount quite easily by making a trade sale to a competitor. An MBO therefore would need to realise a similar amount.

Businesses with a sole owner may be happy with a phased sale but, where there are a number of directors selling, this may not be a practical approach as each may need the cash value straight away to fund retirement.

There is every chance the new management team will have to raise substantial levels of funding as well as needing to replace the skills of the retiring directors. This can be an awesome task, at which many will baulk, and only the brave and ambitious will be prepared to go down the road of high debt and constant management challenges.

There are other issues as well:

1. The value of the business rises as the commission income grows. A potential owner is faced with the situation where the more he pushes the business forward, the more it will cost him to purchase. It may well be a disincentive to drive the business ahead for the benefit of the retiring principal.

2. Agendas will vary if there are a number of owners. Some will not wish to invest time and money close to retirement, frustrating those who want to see the business grow. This can create real tensions.

3. If a number of directors want to leave over a period of years, the youngest could be faced with a formidable task of multiple MBOs with a succession of funding and skill replacement issues.

4. The potential successors may feel that they “own” the business and the clients and are reluctant to pay a full price. “Walking” is a real alternative leaving the principals with nothing to sell.

5. An event such as death, divorce or lifestyle change could trigger the need for an urgent solution ruining the best-laid plans. This may leave a trade sale as the only option.

6. The profitability of the business is such that an MBO is not a viable option.

7. The principals may have little confidence in the management ability of potential successors and have their own secret agenda of selling anyhow, but make encouraging noises to ensure continuing motivation.

8. The issue of succession is not discussed at all in the hope that the problems will disappear.

9. Current interest rates are so low that the selling price will not finance retirement, causing principals to stay well past their sell-by date, frustrating the successors and causing terminal decline in the business.

10. The mountain of debt of an MBO means that the new business cannot invest in acquisition, technology and brand in a period when there are huge opportunities. The business may well sink back into oblivion.

There are unprecedented opportunities for brokers over the next five years, especially the young, ambitious and visionary. But the going will be hard for businesses that stagnate, do not invest and lack the drive to move ahead.

Succession has to be discussed and a plan produced with all interested parties buying totally into the proposals.