Family Business Funding in a Post-Pandemic World

David Baggott: Just try not to over-leverage and try not to be too, let's say greedy from their current generation in terms of extracting cash because that can potentially hinder the future generation and their ability to grow the business.

Natalie Wright: You are listening to the Exploring Family Business podcast brought to you by Mazars. I'm your host, Natalie Wright, head of Family Business at Mazars UK, who has worked extensively with family businesses for a number of years, I'm keen to support this valuable sector of our society. At Mazars, we believe there is nothing more personal than a family business. Every family and every business is unique. We look forward to sharing knowledge, insights, and practical tips for those navigating the unique issues that arise from being in business with family. Now on with this week's show.

Hello, everyone, and welcome back to the Exploring Family Business podcast with Mazars. On March 22, the Bank Of England raised interest rates by a quarter of a percent quickly followed by an identical rise in May bringing the base rate to 1%, the highest rate we've seen in over 13 years. At the same time, the UK recorded inflation in excess of 9% reaching a 40-year high, which is a rate that I can say I've never experienced as an adult. I'm sure many of our listeners can say the same.

Now with concerns that further interest rate rises could be on the cards, and with inflation still spiraling added to the fact that average wage increases in the private sector could be in excess of 4% this year, the macroeconomic environment is not surprisingly causing concern for business owners across the UK. Against this backdrop, we're also hearing that there's still a lot of cash on balance sheets and a lot of money searching for a home in the race to see a real return.

What does this mean for family business funding in a post-pandemic economy? How does this impact the ability of a family business to take on debt, whether that's through, growth through capital expenditure or acquisitions, or even, from the purchase of shares as part of an agreed succession plan? Does this impact decisions around family business transitions from now-gen to next-gen.

In this episode, I'm joined by David Baggott, a director in the Mazars Deal Advisory team. David has over 15 years of experience in advising and supporting family businesses through different transitions. He leads the Debt Advisory service at Mazars, and in 2020, he was shortlisted for the young accountant of the year. I know he has a lot of valuable insights to share with us today. David, thanks for joining us.

David: Thanks, Natalie. Good to be part of this discussion today.

Natalie: No worries. Obviously, I've set the scene there in terms of the macroeconomic environment, and the rising cost of living is a real issue that we're all having to address. Looking at this specifically now, from a business perspective, I'm interested to understand more about the impact that you are seeing in the M&A market and specifically with regard to family and privately-owned businesses.

David: Sure. Just by way of background to me, I work with a lot of privately-owned and family-run businesses and work across a range of transactions, such as sell-side mandates, buy-side mandates, management buyouts, EOTs, those things that you all have heard of. We've seen, over the last 12 to 24 months, one of the busiest periods we've ever seen in terms of a number of transactions, and that's across a range of all of those types of transactions I've mentioned just now, so, buy-side, sell-side, and all of those aspects.

In general, I think the combination of lots of different factors has caused this. Obviously, COVID 19 has had a big impact. Speculation of capital gains tax rises has led to more owners thinking about actually de-risking and potentially taking value out of the business, and then there's been supply chain pressures, rate rises, inflation, and general uncertainty in the market.

There are a lot of different factors that are going on that have forced business owners to step back from the day-to-day operations that they usually have their heads within and focus more so on strategy and what is next. This has led to more discussions around succession planning, around protecting value, around acquisitions to take advantage of these market conditions.

I've also seen a lot more engagements in relating to debt advisory, and that's due to a combination of the factors I've also talked about, but combine that with, at this point in time, a lot of businesses looking to have to repay the government back loans that they've taken out. There are HMRC arrears that have taken place that is getting repaid at this point in time.

Maybe the return to normal market conditions has taken a little bit longer than expected. All of these aspects have meant that there's a rise in debt advisory engagements, and also an increased need to forecast and understand actually where the headroom in the business is and whether the debt facilities are suitable for your business.

In terms of the overall position with lenders, we see there's still a lot of liquidity in the market, and there are many more funding options than there were 10, or 15 years ago. We've seen a flood of alternative lenders to the market that tries and bridges the gap between your traditional high street debts and new private equity and equity providers, which has allowed businesses to take advantage of different debt options in the marketplace.

Natalie: With that in mind then, and with those options to maybe alternative lenders, as well as the mainstream, added to it the rising inflation that we're seeing, which has led into increased cost base across all sectors, are you seeing that there actually is an impact on the ability to raise funds? How's it been different maybe from historical issues?

David: Yes, fundamentally, there will be an impact. As I said, there is liquidity out there. For good strong businesses, there shouldn't be an issue. However, one of the main impacts that I'm seeing at the moment is the lender's assessment of the business specifically in terms of actually looking at the forecasts, looking at the headroom. The diligence is maybe the financials are under increased scrutiny so that the lenders can understand what a maintainable profitability position of the business is to then assess actually, "Can the business service the debt that's going into it?"

As I said, funding is available, but it may take a little bit longer than maybe it has done in the past as there's more scrutiny from the lenders to make sure that they're getting the right level of debt into the business and not over-leveraging based on future forecasts.

Natalie: Are you seeing the difference then in terms of the appetite, whether it's mainstream or mezzanine lenders for providing those funding facilities where it's specifically linked to growth, so acquisition, CapEx expenditure, investing in innovation versus the funding for succession?

David: I think there's always a slight variation between the two. Growth funding is put in place with, more often than not, the expectation that that investment, that cash will generate increased future profits, whether that's an acquisition or investment in new machinery. Those increased profits give a greater ability to service the debt. Whereas for succession, there's not always, necessarily, an expectation that the business will significantly grow to post a transaction, for example, a management buy-out where you sell shares to the next generation.

Therefore there's always a slight difference because the succession route is more so, the debt is going in and cash is being taken out of the business rather than the cash is being invested in the business's future growth. There are options for both. It just needs to be assessed to make sure that there's a sensible leverage level, whichever option you're looking at.

Natalie: With succession in mind then, and I'm sure you'll agree you've seen this, it's certainly something I've seen, it's quite common that the founder of a family business has worn many hats, they've as well as being the MD. They've probably hit some point also being the finance director, ops director, sales director, and even maybe their own HR department. I guess it comes with the territory of starting a business, but as the business matures, and as you see another generation rising through, there is a need to transfer that knowledge and provide the opportunities for others to learn so that they can be making the decisions.

What do you see as the greatest financial challenges in a family business where you are transitioning from now-gen to next-gen?

David: You've mentioned some of them there. In terms of, my perspective, from a purely financial point of view, there are similar challenges in a family business to any other business. I'd say the key difference or the key challenge is ensuring the right levels of responsibility for the skill sets that the next generation has. I'd say, don't be afraid for the next generation. Don't be afraid to bring in experts or try and up-skill the management team as it may be required. Not everybody has the same skill-sets as the previous generation, so it may be required. Also, there are likely to be different challenges. The market has changed significantly over the last two years with all of the different factors that we've talked about here. There are likely to be further changes and challenges in the future. Therefore it's just making sure that the management team that's driving the business forward has the right skill-set to be able to deal with those challenges.

Natalie: In many cases, the next-gen then possibly haven't been involved in that decision-making process when it comes to raising funds, that they may never have had to do it within the business. This may be the first time. I do wonder, you've potentially seen a different risk appetite for the next-gen versus the now-gen, which could be for various reasons, age, personal circumstances, that potentially got a longer time horizon. How would you explain the process to the next-gen then specifically when it comes to accessing those funds for growth?

David: Just touching on the risk appetite, I'd probably say the risk appetite is more of an individual personality trait. Some businesses and some business owners accelerate growth by using debt, but these owners understand and accept the risks of this. Whereas other owners would rather build the cash reserves first and then use that for investment and growth and accept that the business may not move forward as quickly as maybe other businesses. A lot of times this is potentially more of an individual character and personality preference rather than one generation to the next.

Moving on, in terms of the process of accessing funds, the first port of call is always a forecast and scenario plan. Understand actually where the business is in terms of current performance and where it's expected to get to in terms of future performance to then allow you to understand the level of funding required and if, in a growth scenario, the benefits and returns that that funding will bring.

The next step, once you've appraised that and understood that is then to produce, essentially a funding pack, a little bit of a sales memorandum that you can speak to, either your bank or the lenders, to use for initial discussions, to provide them with enough details, to make an informed offer on funding terms. Once you've spoken to the lenders, it's then going through a process of understanding their requirements, going through diligence, and overlaying their debt structures onto your forecast to understand what works from their point of view and your point of view.

Generally, I'd say speak to advisors like us because we can work with you from the initial assessment, helping you compile the financial forecasts and scenario plan through to executing an injection of funds.

Natalie: Lots to consider there. I guess it comes back to your other point. If you've not been through it before, if you don't know the process, you don't potentially have the skill-sets in-house, the best thing to do in any type of business is always to go and seek that professional advisor that you're moving in the right direction.

We talk a lot, and we have done throughout the series, around some of the decision-making within family businesses is different because of the personal relationships, and the personal impacts of decision-making. If then we were thinking about this in the context of the process of funding for expansion and innovation, is that different within a family business than a non-generational business?

David: I wouldn't say so from a perspective of a lender, however, the family dynamic can create differences. Thinking of it from a lender's side of the fence, a key question from their perspective is, "Will the business be able to service the debt and repay us?" To answer this, there'll be diligence of the financial aspects, but also, which individuals are driving the business forward and are therefore responsible for ensuring that the business repays the debt out to the bank or the lender?

That's a key part of a family business. It's key to ensure the business owners are wearing a business hat and not always a family hat to make sure that the decisions made in terms of the right management team and the right governance structure is from a business perspective and not always from a family perspective because that may get picked up on in terms of the lender assessment of putting money into a family business.

Natalie: It's important then to be engaging the next generation for that future success so that you can answer these types of questions and you've got a clear path. It's not just knowing where each individual is. It's actually, how does that feed through to the business and the finances and other things?

David: Exactly. In terms of the next generation, having that assessment of the skill-set and the management team, "Are they appropriate for the future direction of the business?" it can be that the next generation is family plus non-family members. Whereas historically previous generations, it could have just been family members, and that may be putting the business hat on and saying, "Look, that's the best position for the business." Maybe not necessarily for the family in terms of giving away equity, however, it could benefit the family in the long term if the business does grow to that next level that actually it maybe couldn't have done if it just did remaining within the family.

Natalie: Often being multi-generational, I guess we know that family-earned businesses do tend to take that long-term view. They tend to be nimble. They can pivot when they need to, but they also tend not to be reactive just because the external factors are changing. Is the current environment on the back of an uncertain two years following the onset of the pandemic? Do you think that's leading to an acceleration in succession planning quite possibly for personal reasons? What impact do the rising rates have on that process?

David: I do think there's an increase in conversations around succession and movements forward because everything that's gone on including rate rises, inflation, and all of the macroeconomic factors are forcing the families and the owners to think about the future and what they want to achieve, what are their ultimate goals? and who's the best place to take the business forward.

Going back to the forecast point, it's really important to plan and to understand actually, where's the headroom in the business going forward? If there is a transaction such as a management buyout that is happening, there may be an impact in terms of not being able to take as much cash out of the business as may have happened previously, purely because all of these factors are meaning that there's less headroom within the business and within the funding facilities that the family business has.

Natalie: I'd certainly echo what you've said that working with families on a personal basis, I'm certainly seeing more acceleration around the succession and the actual planning around it, whether that is, "Do we bring the next generation in perhaps earlier so we can exit earlier? Or do we bring them in now, so they've got more of a skill set and more experience ready to take the business forward?" I think even more so highlighted because of what's happened in the last two years and that need to be able to respond and move the business forward quickly.

With that, what one piece of advice could you give to a family business that wants or needs funding, but has been hesitant may be to think about debt or external investment? That's whether it's for growth or succession purposes.

David: I may sound like a broken record here, but from a growth perspective, forecasting is the first point and that's really important. That then allows you to overlay different scenarios and understand how debt used appropriately can help with your plans. Many clients maybe don't want debt in businesses. I probably see this more so within family businesses, however, if used appropriately it can deliver accelerated growth and greater returns. Those that use debt can potentially buy and invest today, versus those that save and then will buy and invest in the future. Therefore using debt appropriately can help unlock future growth and future opportunities.

From a succession point of view, a key piece of advice is just to try not to over-leverage and try not to be too, let's say, greedy from the current generation in terms of extracting cash because that can potentially hinder the future generation and their ability to grow the business. Actually, the bigger level of value could be in the future growth of the business. You wouldn't want to over-leverage it now and hinder that growth because of debt costs and constraints on being able to grow the business for the future.

Natalie: One takeaway I've got from that is that debt doesn't have to be negative. If you have a clear plan, it could actually be one of your greatest assets.

David: Exactly. I think you've summarized my waffling quite well then.

Natalie: Brilliant. Thank you for that, David. Thanks for your time today. I'm sure there'll be lots of takeaways for family business owners who have been grappling with that idea of funding and maybe haven't been through it before. I'll leave your contact details in the show notes for anyone who does want to connect with you to discuss any of this further. I'm just going to close with two quickfire questions. Can you tell me your favorite well-known family-run business and the reason why?

David: I've worked with a lot of family businesses, not all that well-known, but the best ones are those that balance business and family and have the family values but the business traits to move forward. I'd probably clock one out of the air in terms of the more well-known family business being somebody like Warburtons that has passed through four or five generations and still going strong, and it's a well-known brand out there.

Natalie: Great well-known business as well. Final question. Can you share with us a podcast or book recommendation for rising family business leaders?

David: Yes. I've listened to a few family business podcasts from Russ Haworth. One of them is quite interesting in terms of highlighting family business well from the opportunities for future generations. The one takeaway that I took from that was that a family business wealth can pass through generations within a business, but actually, the next generation may not want to continue the business, but the family business has enabled them the opportunities, the wealth from that business growth, has enabled them the opportunities to go and do whatever they want to do.

It could be staying within the family businesses or it could be extracting cash to allow them to go and pursue their own dreams, and the family wealth continues in a different direction in the future.

Natalie: I know that episode well. I've listened to it myself. Russ is doing great things in the family business community. Joined us on the last season as well, so yes, we can put a link to that in the show notes.

Thanks for that, David. That brings Episode 5, the third season of the Exploring Family Business podcast with Mazars, to a close. If you enjoyed today's show, please subscribe to the series and leave a review on Apple Podcast. It will help us to extend our reach to the family business community.

Join me in the next episode when I'll be speaking with Fiona Graham, Director of Affairs and Policy at the Institute for Family Business, along with the newly appointed CEO of the IFB, Neal David. The IFB support and champions UK family businesses so that people, communities, and the economy, can thrive. We'll be discussing the wider impact of transition between generations. I look forward to sharing more with you then, but for now, thank you for listening.