The Operation of the Sme Transfer Market-uk-2007

8/14/2019 The Operation of the Sme Transfer Market-uk-2007

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THE OPERATION OF THE SMETRANSFER MARKET

Policy Research Team:

Gordon AllinsonPaul Braidford

Maxine HoustonPaul Robson

Ian Stone

Report for BERR and UK partners

Centre for EntrepreneurshipDurham Business School

URN:07/1691

July 2007


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Contents

Executive Summary........................................................................i

1 Introduction............................................................................11.1 The research project.....................................................................................1

1.2 Size of the transfer market............................................................................1

1.3 Types of market failure.................................................................................6

1.4 Purpose of study............................................................................................9

2 Scoping business transfer issues............................................11

2.1 Market options for buying and selling.........................................................11

2.2 Factors affecting transfer............................................................................12

2.3 Matching databases....................................................................................15

2.4 The borrowing environment........................................................................16

2.5 Using intermediaries...................................................................................17

2.6 Targeting policy: segmenting the market...................................................19

3 Focus groups findings............................................................21

3.1 Use of intermediaries..................................................................................21

3.2 Routes to selling and purchase...................................................................22

3.3 Policy options to address market failure.....................................................26

4 Survey of exiting owners........................................................30

4.1 Profile of sample..........................................................................................30

4.2 Types of exit................................................................................................314.3 Form of Exit.................................................................................................32

4.4 Determinants of exit decision......................................................................33

4.5 Finding a buyer...........................................................................................34

4.6 Employee buy-outs......................................................................................35

4.7 Experience in relation to expectations........................................................35

4.8 Policies for improving transfer.....................................................................36

5 Survey of buyers....................................................................38

5.1 The sample..................................................................................................38

5.2 Why buy?.....................................................................................................38

5.3 Use of intermediaries..................................................................................40

5.4 Finding a business to buy............................................................................42

5.5 Buying the business....................................................................................44

5.6 Experience in relation to expectations........................................................47

5.7 Post-transfer performance...........................................................................48

5.8 Differences by area of the UK......................................................................52

5.9 Policies to improve transfer.........................................................................53


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6 Conclusions on market failure.................................................54

7 Policy and further research.....................................................57

7.1 Policy indications.........................................................................................57

7.2 Further research..........................................................................................59

References..................................................................................61

Appendices.................................................................................63

AcknowledgementsThe authors would like to thank all business owners, intermediaries and practitioners whoattended focus groups or gave interviews in connection with this study. The report has alsobenefited from the helpful comments of David Purdy, Andrew Lincoln and Phil Mercer (ofBERR), and members of the Steering Group, including representatives of the WelshDevelopment Agency, Invest Northern Ireland and the Scottish Executive. Andrew Hunt andZilia Iskoujina (of DBS) provided, respectively, useful advice on statistical testing and focusgroup support.


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EXECUTIVE SUMMARY

One tentative estimate places the incidence of transfer failure ataround 100,000 per year, although many of these failures involvemicro businesses, with few assets or employees, and which may not be

viable candidates for transfer. Through a literature review, focusgroups with those buying and selling businesses and intermediaries inthe process, as well as separate surveys of both buyers and sellers thisstudy aims to provide a better understanding of the operation of the UKmarket for the buying and selling of SMEs.

The research was founded upon the broad economic principles ofmarket failure: that the commercial transfer market may operateimperfectly, leading to a lower than optimal number of businessesbeing bought and sold. The research project aimed to determine theextent of failure in the transfer market and suggest possible routes

towards improvements in the market's efficiency and effectiveness.

OPTIMISING TRANSFERS - KEY FINDINGS

Exiting owners perspectives

Size and sector of business appear to be the most significantdeterminants of the type of exit planned. Smaller businesses (which inour survey also tended to have older owners) and manufacturers wereless likely to plan actually to sell than other types of business.

Although many sellers were nearing retirement age, only 17% had a

detailed exit plan. This limited their options and increased thelikelihood of a low final purchase price or transfer failure. Owners oflarger businesses and those who had already successfully transferredwere more likely to have a plan.

Over two-thirds of those intending to sell had received an approach tobuy. These often took the form of speculative enquiries from abusiness transfer agent. Business agents/brokers, accountants andnetwork contacts were the three most frequently used sources to find abuyer and were regarded as the most useful.

Purchasers perspectives

Buyers of businesses were largely motivated by pull factors (a newchallenge, a capital gain etc.) rather than push factors, such as losingtheir job. Men were more likely to be motivated by the financialaspects of a purchase than women. Relatively few (16%) werecompletely against starting a business from scratch; those who werereported they had more managerial than entrepreneurial skills.

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Purchasers were generally satisfied with the quality of advice andsupport they received. Solicitors, accountants and independentfinancial advisers were highly rated and usually already known to thebuyer. Specialist intermediaries, including business brokers, were usedby relatively few and were not highly rated.

Purchasers reported relatively few difficulties with the transfer process 60% thought it easy or very easy. The process also tended to berapid - over half of the successful purchasers completed their purchasewithin three months of identifying a target business. The smaller thesize of the workforce, the more rapidly the purchase tended to becompleted.

The majority located their target business through informal means,usually via a representative of the business itself or existing businessand personal networks. Indeed, around 1 in 3 did not search for a

business at all, either having been offered a business or only everhaving a single target business in mind.

Over half were only prepared to look in their local area, with mostpurchases occurring within 5 miles of their home base. Formal searchmethods advertising or the use of a transfer agent or otherintermediary were far less used, though use of the internet washigher in Scotland (17%) and Wales (10%) than in England (3%).

Overall, only 12% of purchasers found it more difficult than expected tofind finance. The overwhelming majority (75%) used their own savingsand/or a standard bank loan. However, some would-be purchasersperceive that banks prefer to offer special deals for business start-upsand they may be deterred from pursuing loans to buy a business bytheir perceptions of a lack of such deals.

Women tend to buy smaller businesses than men, and are more relianton loan finance.

The mean proportion paid in intermediaries fees was 7% of the askingprice, in line with targets suggested by specialists. Over one in four saidfees were higher than they had expected, with Scottish and Welshpurchasers more likely to report both higher fees and that the processtook longer than anticipated.

The majority of businesses performed well post-handover, indicating thatpurchases were worthwhile. Some 28% reported a decrease inemployment following purchase, although a substantial number of thosebuying businesses with no employees went on to recruit at least oneadditional person post-transfer.

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Why the market fails

There is no overall failure in communication of the intention to buy orsell informal networks and advertised sales work reasonably well formost buyers and sellers. However, these systems tend to work lesseffectively both for female purchasers and in more deprived areas.

There is greater evidence of market failure related to intermediariesand due diligence. Buyers and sellers often do not choose the bestqualified intermediaries for transfer; intermediaries initial estimates oftime and cost are often too low (particularly among legalprofessionals); and sellers may inadvertently fail to reveal all pertinentinformation. These difficulties increase the costs and duration oftransfers and the likelihood of the process failing.

Potential purchasers may be deterred, or scale their ambitions down, dueto perceptions that the fiscal regime and financial institutions treat start-

up more favourably than purchase.

Improving outcomes: policy implications

Steps should be taken to bolster networking, particularly amongstgroups with less extended contacts for example women or those inmore deprived areas.

To produce more realistic estimates of time and costs involved, thetransfer process should be made more transparent and streamlined.One-stop shops could provide basic information on business transfer,particularly to sellers, while intermediaries could increase their use of

continuing professional development courses. SME owner-managers must be made aware of the need to plan for exit

and their capacity to do so has to be improved. This could beachieved via trusted intermediaries, such as accountants.

Though finance generally was not a problem, the most common policysuggestions were (i) the tax regime should treat purchases asanalogous to start-ups, (ii) loans could be introduced specificallytailored for business transfer, ideally backed by government guarantee.However, there is no evidence that the tax system does discriminate,suggesting a need for better information, rather than fiscal reform.

Those with no prior experience of selling were most likely to supportpolicies designed to address their lack of knowledge, such as one-stopshops, mentoring, and a self-analysis toolkit.

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Factors which improve the likelihood of successful transfer

Businesses in unopposed or less competitive markets, with a nicheposition or unique assets, are more likely to sell successfully

The transfer process should be standardised and streamlined as far aspossible.

The more knowledge a seller has about transfer before initiating a sale,including their own prior experience, such as research onintermediaries, tax issues etc., the more likely the sale is to besuccessful.

Sellers need to be realistic and flexible over their asking price, and tryto ensure that their assessment of the value of their business is asobjective as possible.

Internal disputes need to be resolved before a business is offered forsale, and should not be allowed to delay or raise the costs of a transfer.

Effective networking and word-of-mouth are the preferred routes toselling, and most transfers seem to be initiated via this route.

Anonymity and discretion during the initial stages of a sale areimportant, in order not to jeopardise business performance.

Sellers should engage intermediaries with business transfer experienceor training,, preferably those recommended by other businesses. Theyshould be able to place faith in such intermediaries: that they willperform efficiently and provide accurate information about costs andprojected timescale(s) at the outset.

Agreed timescales and deadlines then need to be adhered to byintermediaries, possibly with penalties imposed for lateness.

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1 INTRODUCTION

1.1 THE RESEARCH PROJECT

In the view of the European Commission (EC, 2002) the failure of businesssuccession presents a potential threat to the survival of SMEs and, therefore,to output and employment growth. This in turn implies that the transfermarket needs to be developed to operate as efficiently as possible. Earlierwork by the Durham Business School team (SBS, 2004), drew attention to theknowledge gap regarding the operation of the market. This study,undertaken in 2006 by Durham Business School, on behalf of the SmallBusiness Service (in collaboration with the Welsh Development Agency,Invest Northern Ireland and Scottish Executive), is intended to provide abetter understanding of the operation of the UK market for the buying andselling of small and medium enterprises (SMEs). More specifically, the study

asks whether the commercial transfer market operates imperfectly, resultingin a lower than optimal number of businesses being bought and sold. Itshould be stressed that the policy aim should not be to ensure that everybusiness is sold, but rather that viable going concerns, otherwise facingclosure, are successfully transferred to new owners, rather than lost to themarket. In light of this consideration, it assesses whether there is a case forintervention and, where appropriate, suggests suitable action to addressobstacles to business succession.

This study seeks to provide the first comprehensive picture of the UKbusiness transfer market, drawing on evidence derived from three main

research stages: (a) a literature review and interviews with relevantstakeholders and intermediaries to scope the research (see Section 2); (b) aseries of focus groups, held throughout the United Kingdom, to identify keyavenues for investigation (Section 3); and (c) two surveys, one questioningthose who were either in the process of selling or closing their business(sellers, Section 4), the other focused upon those who have bought abusiness (buyers, Section 5).

This section provides background information on the transfer market and itsoperation, gauging the scale and characteristics of: (1) businesses for sale inthe market; (2) businesses demanded; (3) completed sales and closures; and

(4) transfer failures. It goes on to set out the ways in which market failurecan interfere in the process of buying and selling of firms, and also provides aframework for systematically assessing key aspects of both market processesand outcomes, distinguishing carefully between successful and unsuccessfultransfers.

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1.2 SIZE OF THE TRANSFER MARKET

No definitive estimates exist of the number of business for sale in the UK, thenumbers that find a successor or of viable business that fail to transfer. Whiletransfers of larger businesses tend to be widely reported, those of smaller

businesses go largely unnoticed. This section brings together fragmentedinformation from the literature relating to the supply and demand ofbusinesses, as well as sales and transfer failures.

Supply and demand estimates

Regarding the supply of firms, there is no requirement to notify governmentagencies of a sale, nor can a transfer be captured easily, through sourcessuch as Companies House records. While estimates have been made in anumber of countries, definitions and measurements vary and divergences intransfer rates result from cultural, legal and political differences (Morris,2004). Recent estimates of the number of firms for sale have arisen out of

European Union concern about the potential impact of an ageing populationupon succession. It has been argued that an average of one-third ofenterprises in Member States would be subject to succession over thecoming decade (EC, 2002). On reasonable assumptions, this translates toaround 3% of SMEs with employees (equivalent to 40,000 firms annually)potentially undergoing a transfer of ownership, but as we have arguedpreviously (SBS, 2004) - the method by which the EU figure is derived wasrelatively crude.

A UK perspective on sales is also provided by the SBS Annual Small BusinessSurvey (SBS, 2006) which found that 22% of owners wished to sell the

business when they retired, compared with 25% who would try to pass it onto a family member and 36% who had no current plans. Businesses withemployees were more likely than those without to be planning a sale (26%versus 20%) and micro businesses were more likely than either small ormedium businesses to be planning to sell (27%, 24% and 22%, respectively),even though the pattern of actual sales tends to increase with firm size.Sectorally, services business owners were substantially the most likely tointend to sell (29% of respondents), followed by production (23%).

In addition to the influence of demographic structure, there is strongresearch evidence pointing towards increased commercial (i.e. extra-family)

succession. Studies of family business succession, in Germany, Austria andthe Netherlands, have found that the proportion of businesses passed on tothe next generation is steadily falling, implying another source of growth incommercial market transfers (SBS, 2004).

On the demand side, purchasers of businesses are often other firms, and thepropensity for acquisition is known to increase with firm size. A recent UKstudy showed that under 3% of micro firms had acquired another firm (or

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firms), compared with 10% of small firms and 23% of medium-sized firms(Cosh and Hughes, 2000; 2003). The survey data for 2002 showed that 18%of firms had themselves received a bid or merger proposal in the last twoyears; again varying on the basis of size: 9% of micro, 22% of small and 26%of medium businesses (Cosh and Hughes, 2003). In addition, innovation,

growth and profitability were all found to be positively related to being a bidtarget. Innovators (23%) were twice as likely as non-innovators (11%) tohave been a bid target, while high employment growth (25%+ in last 3years) firms were more likely to have received a bid (24%) than firms withzero or declining employment growth (14%).

Demand for firms by individuals is restricted by a widespread preference forstart-up over purchase of a going concern. More than six out of ten potentialentrepreneurs in the Netherlands would rather start their own business thanbuy one (Netherlands Ministry of Economic Affairs, 2003). Both the SBSsHousehold Survey of Entrepreneurs (2005) and the Federation of Small

Businesses Members Survey (2004) indicate that three-quarters ofentrepreneurs start a business from scratch, rather than purchase one, whilefewer than 15% of exiting entrepreneurs go on to buy an another existingbusiness (Stokes and Blackburn, 2001).

These findings help to explain why demand for firms is considerably belowsupply (West, 2004; Meijaard 2005). With substantial numbers of smallbusinesses for sale, and relatively few potential buyers, purchasers cancherry-pick the best firms on the market. This tends to work against manybusinesses seeking to transfer ownership that are in older, declining sectors,rather than the dynamic, growing industries preferred by entrepreneurs

(Voithofer, 2002).

Overall, therefore, it seems that the size of a firm is instrumental - the largerthe business, the more likely it is to be the subject of a takeover or mergerbid, and to be actually taken over, as well as to be the purchaser of anotherbusiness. The implication is that the transfer market among largercompanies is relatively more efficient, and that efforts to address marketfailure might best be directed towards companies at the smaller end of thescale.

Transfer failure estimates

Passing the Baton (SBS, 2004) defined succession failure as a situationwhere, other things being equal, the business either closes or is diminishedowing to deficient succession processes. It is distinguished from businessfailure, which refers to closure of the business because it has becomeunsustainable as a commercial entity. Thus not every closure representssuccession failure. While some research gives us an idea of the scale oftransfers in relation to closures - e.g. actual transfers in the Netherlands

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amount to under a third of the number of exits (Meijaard 2005) - it tells uslittle about the incidence of transfer failure.

Drawing upon research by Stokes and Blackburn (2001) and Voithofer (2002),we previously suggested, tentatively, that business transfer failure i.e. the

closure of a viable business because no suitable successor could be found accounted for between 28,000 and 46,500 of the 155,000 closures recordedin VAT records for 2002 (SBS, 2004). It was further suggested that, includingthose not VAT registered, the true number of transfer failures may exceed100,000. A large number of these failures may actually be one-personbusinesses: estimates from the USA suggest that only one in 5.5 businessesfor sale of 9 employees or fewer (less than 4% of the micro-business stock)will actually sell (West, 2004).

Refining the terms failure and success

Given the range of possibilities inherent in the process of selling, it is helpful

to visualise outcomes relating to succession and how these might relate tomarket failure. Figure 1 tracks the process of business transfer from the firstdecision made by the seller and the prospective buyer, through to thecompletion or failure of the sale. This is a broad outline of the processesinvolved, and cannot be a comprehensive representation of all relevantfactors. For example, if a buyer learns of a business for sale directly from theseller or via a trusted network, both parties could make the leap fromdecision to buy/sell to initial contact without any intervening steps.Similarly, such factors as the general economic context of the area in whichthe business is located, the level of interest rates and whether the targetbusiness is in a declining or growing sector, will also have an effect on thecourse and outcome of the transfer process.

Of the six options presented at the bottom of the diagram, the only one thatrepresents a market success is Outcome 1, the business selling for a trueand fair price. Here, neither the buyer nor seller lose out, having fairlyexchange the business at its true value.

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Figure 1The process of buying or selling a business

Decision to sell Decision to buy

Contacts one or more sources

ConsultantsPublic bodyBusiness Link

Chambers ofCommerce

Localauthority

Trade/professionalassociation

BrokersCustomersSuppliers

LawyerBankAccountant

ConsultantsPublic bodyBusiness Link

Chambers ofCommerce

Localauthority

Trade/professionalassociation

BrokersCustomersSuppliers

LawyerBankAccountant

Contacts one or more sources

Approaches broker to sell business

Advertises business online

No

Advertises business in press

Extra costsYes

Approaches broker to buy business

Views onlineadverts

Views pressadverts

No Yes

Extra costs

INITIAL CONTACT

Confidentiality agreement Deposit requested Due diligence/negotiation

Price and conditions of sale agreed

Finance in place?

SALE COMPLETED

Yes

Yes

BUSINESS DOES NOT SELLNo

No

Correct, true and fair price paid

Price less than true and fair price

Price above true and fair price

Keep business going

Redo process

Close business

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Outcomes 2-4 offer the greatest scope for analysis of why, how and at whatpoint the process could fail, summarised in Table 1.

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Table 1 Possible reasons for failure of business transfer process

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2 Price above fairvalue

3 Price below fairvalue

4 Keep business going

Result good for seller,poor for buyer

Result poor for seller,good for buyer

Lack of availability offinance from banks etc

Failure to carry outdue diligence properly- by buyer and/or byagents?

Seller may not havesought advice fromprivate/public sources

Due diligence raisesunanswered questionsabout strategy, growth,prospects and,especially, staff

Failure to take advicein process by buyer

Broker may not havebeen used by seller

Buyers and sellers notflexible enough

Poor job by buyersadvisers

Seller may not haveacted on advice

Seller not ready to sell,or not prepared todevote enough time to

process Poor job by buyers

broker or agent Adviser or broker did

not perform jobproperly

Time and resourcesspent with no return, byboth parties

Insufficient number ofbuyers?

Market worked?

The market worked therefore the initialasking price was toohigh!

Failure to ask permissionto talk to keystakeholders couldcause tensions

Seller did not havesufficient knowledgeof process of buyingand selling

Seller did not havesufficient knowledge ofprocess of buying andselling

Buyer did not havesufficient knowledgeof process of buyingand selling

Buyer did not havesufficient knowledge ofprocess of buying andselling

Too many (un-needed)assets included?

IP industry? problemswith value and sale of IPassets

Person-specific industry? so, of little value to sell

Declining industry?

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Too much competitionand/or easy entry

Outcome 5, repeating the selling process, would lead to more expense forthe seller, threatening jobs, investment and growth, and could damage theviability of the business because of its apparent lack of attractiveness in thejudgement of other prospective purchasers. Outcome 6 can be seen as arelatively straightforward business failure, not a transferfailure the owner,having exhausted all means of keeping the business going, decides to close.However, Outcome 6, as noted previously, may not in fact be indicative ofthe failure of the transfer market, but rather may be a sign that the market isoperating efficiently and that the business is unviable.

It is also possible that Outcome 3 could be seen as a form of success fromthe point of view of the economy as a whole, if it releases resources andallows value gains which benefit economic performance in subsequentperiods. However, over the longer term, this outcome still might bedamaging to the economy in that it might discourage those who make apractice of forming companies specifically for market-based disposal.

1.3 TYPES OF MARKET FAILURE

As well as the difficulties of accurately estimating the size of the UK businesstransfer market (and that of related failures), there is a lack of knowledgeabout the transfer process itself. Research has been lacking in thefunctioning of the market with respect to succession, even though studies

(such as that of several northern European countries by Geerts et al., 2004)reveal that some two-thirds of owners experience problems with commercialtransfers - particularly takeovers and management buy-outs (MBOs)compared with family successions. In fact, much of the extant literature onbusiness transfer concentrates on intra-family succession, even though onlya minority (and falling) share of transfers occur via this route (e.g. 30% in theUSA, 22% in the Netherlands) (van Teeffelen et al., 2005; Howorth et al.,2004). If the market is indeed found to function ineffectively, this presentsan additional problem, as it may send discouraging messages about theprospects of eventual exit to those considering start up.

Market failure, as used here, refers to imperfections in the market resulting ina lower than optimal number of businesses being traded. Optimality heredoes not mean that everybusiness on the market has to be sold (akin tomarket clearing); indeed an efficient market should weed out those which areuncompetitive or commercially unviable and the failure of some businessesto find a buyer may not be market failure, but rather market success.Indeed the market would be deemed to fail if an uncompetitive businessfinds a buyer, but is forced to close shortly after the sale. As well as

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achieving the optimal number of sales, a successful market would alsoensure that if a business transfer occurs, it does so at the optimal price i.e.one which reflects the true value of the business, ensuring that seller andbuyer receive a fair deal. Morris (2005) goes further. Noting that fewer than10% of start-ups achieve meaningful growth, and only 4% will ever create

100 jobs or more, he concludes that, even if a business is viable, convertingexits to transfers may not offer much promise (p. 45).

There are two main areas in which the business transfer market can fail,focused around (1) information flows and (2) principal/agent problems.

Informational aspects

Difficulties in signalling the intent to buy or sell. With no centraldatabase of businesses for sale or registry of buyers, the methods tomatch buyer to seller can be somewhat haphazard, potentially expensiveand time-consuming, and the opportunities available to both parties are

restricted. There may also be difficulties in identifying an appropriatesource of advice or information, and/or in judging the skills or the value ofadvice given by an intermediary or agent. Many buyers and sellers lackexperience in the business transfer market, often only ever beinginvolved in a single such transaction, which may also make it difficult forthem to communicate their requirements effectively. There are threetypes of possible failure here: (a) that a seller will fail to locate anysuitable buyers, and thus be forced to close; (b) that a seller will locate asub-optimal number or type of buyers, and may be forced to sell thebusiness at a price lower than its true value; and (c) a buyer will fail tolocate a suitable business to purchase, and settle for a sub-optimalpurchase, abandon search altogether or opt to start a business fromscratch.

Once a target business has been found, the biggest problem faced bybuyers and sellers is that ofinformation asymmetries. Essentially, theseller knows more about the business than the buyer, and it may be inthe sellers interest to not fully disclose certain details about theirbusiness (beyond minimum legal requirements) in order to maximise theselling price. While it is possible for buyers to inspect the businessaccounts, the quality of the stock, building fabric, fixtures and fittingsetc., less tangible indicators of value may remain more obscure, and may

possibly be concealed or distorted by the seller (e.g. goodwill of clients,prevailing or prospective competitive climate). Alternatively, the sellermay exaggerate the value of intangible aspects of the business, whichmay be difficult for a potential buyer to verify. Information asymmetriesmay also affect availability of finance to potential purchasers, sincelenders are trying to assess the suitability of the borrower to run abusiness and the business itself as a sound investment, both of which

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contain intangible aspects which may be hard to communicate to a thirdparty.

There are similar issues associated with the valuation and transfer oftacit knowledge. Though not necessarily withheld purposely, in very

small companies especially, the skills and knowledge underpinningbusiness success may be embodied in the owner-manager themselves.The tacit knowledge of the owner can comprise a large proportion of thecompanys assets; this can only be passed on via a potentially lengthyand intensive handover period. As National Underwriter(23.2.04) put it:A lot of times, what entrepreneurs do is create a job only they can doSo, when they are looking for a successor, the only person who can do thejob is them. Placing a value on such knowledge is difficult and can causeproblems in selling the business. A similar problem may arise withcompanies based around intellectual property (IP) assets. Issues ofcopyright and ownership can make such firms tricky to value and sell; as

also applies where valuation is based on nebulous concepts, such asreputation, goodwill or potential, rather than a more concrete assetbase.

The accounting regime, future projections and planning of small businessowners are often less focused, more idiosyncratic - or simply non-existent compared with larger firms with a more defined management structure.Similarly, the drive to maximise profits among such firms can be lesspronounced, with the owner-manager content to settle for making acomfortable living, rather than maximising business potential. These so-called lifestyle businesses may fit well with the owners (and their

familys) way of life and financial needs, and relatively little thought maybe given to passing them on to another owner. Indeed, research hasfound that the main objective of businesses transferred intra-family isoften simply continuity of business, while external transfers emphasisedincreasing growth (Geerts et al., 2004). Therefore, when the time comesto sell, lifestyle-oriented owner-managers tend not to have prepared asuccession plan, and find it difficult to make the business market-readyin the time available. These failures in management commonly rendersuch businesses relatively more difficult to sell.

As well as incomplete or distorted information, there exists the possibility

that there may be systematic misperceptions relating to certainaspects of the business transfer process. For example, potentialpurchasers may have a distorted impression of the availability of financefor business purchase, the length of time it would take to buy a businessor the typical price, which may deter them from even thinking aboutpurchase. Similar issues (relating to starting a business) are explored inmore depth in SBS, 2005.

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Principal-agent problems

At many stages in the business transfer process, the buyer or seller (theprincipal) is likely to engage an intermediary (the agent) to act on theirbehalf e.g. specialist business brokers through to lawyers, accountants etc.However, it is difficult for the principal to monitor the actions of the agent,

and the incentives of the agent may well differ from those of the principal.For example, a broker may seek to maximise his commission from a sale,recommending a business which may not always represent the bestopportunity for the buyer or may be some distance from their ideal targetacquisition especially given that repeat business is unlikely.

As already stated above, many buyers and sellers lack experience in thebusiness transfer market, often only being involved in a single suchtransaction in their lives, making it difficult for them to effectively evaluatethe skills or the value of advice given by an intermediary or agent. Theremay be concerns about the qualifications of some of those involved in

business transfer, and straightforward incompetence or malpractice couldlead to a failure in business transfer. It should be noted that difficulties existfor owner-managers in the assessment of the competence, accreditation andqualifications of intermediaries, given that they only rarely use such services,and may have a limited number of choices in the locality.

In other words, as well as the potential market failures inherent in thebusiness transfer process itself, there are additional problems in the marketfor obtaining advice, support and services from intermediaries. Therefore, toaddress difficulties in the market for buying and selling businesses, theproblems in two separate markets must be investigated the market in

businesses themselves, and the market for services ancillary to buying andselling.

Other forms of market failure

Succession outside the family tends to be the less preferred option of manyfamily business owners (who do not want to part with the family silver), andcommercial transfer is viewed as the next best (i.e. suboptimal) option.There is some evidence however, that this attitude is changing (SBS, 2004),and that the concept of an inter-generational family business is not always asattractive as it used to be. Non-family succession in SMEs in fact appears to

be more favourable to economic development and growth, although theactual transfer process itself tends to be more complicated and prone tofailure (Geerts et al., 2004).

For larger businesses taking over a small firm, the situation may besomewhat different an interviewee noted that when smaller firms becomepart of a larger corporate structure, they may not be able to be run in thesame penny-pinching fashion as applied to the original owner. They may

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even have to comply with legislation that has formerly been evaded, so thatthe acquired firm does not improve its performance to the degree expected.In such cases, the seller may well receive the true value of the company toanother individual or small firm, but the small firms ultimate value to thelarger buyer is somewhat lower. This represents a market failure in the

sense that an identical product is worth different amounts to differentcategories of buyers what could be referred to as a segmented market.

Other reasons for the value of a business differing between individuals, relateto more intangible aspects for example, the seller of a small, profitable localretail outlet may not attract many potential purchasers, as they may not wishto work the long hours typical of the sector.

1.4 PURPOSE OF STUDY

While the preceding discussion implies that the marketplace for businesstransfer is not perfect, this does not imply aprima facie case for governmentintervention. As has been pointed out (SBS, 2004; Martin, 2005), there hasbeen relatively little evaluation of government initiatives aimed at thetransfer marketplace. Policies to date have tended to be based on relativelysmall-scale studies, and estimates of the increased number of transfers arevague and not backed up by hard evidence. Similarly, there has been noattempt to comprehensively track the quality of transfers under variousofficial schemes and projects. This distinction is important. For instance,while it is asserted (by those operating it) that a government-initiatedGerman matching database has increased the number of transfers by 10-

15%, there is no information on: how successful these transfers have been;whether the transferred companies have survived in their original form orhave simply been asset-stripped; whether any external economic factors mayhave played a part in the increase in numbers; or whether the transferswould have gone ahead anyway, without the database. In effect, in manycases, it is plausible that only the route of the transfer has been slightlyaltered, to be brought under the auspices of official statistics.

On a wider, macroeconomic scale, ensuring that business transfers succeedand contribute to economic growth is clearly a worthwhile policy objective.Research by Geerts et al., (2004) showed that businesses which aresuccessfully transferred to new owners experience growth in turnover, profitsand customer base, and to a greater extent than intra-family successions.Employment, however, tended to fall slightly, as new owners undertookrestructuring for efficiency reasons, which family successors seem less likelyto do. Mandl (2004) also reported positive results associated with businesstransfer, finding that 96% of transferred Austrian businesses were stilloperating after five years, compared with just 75% of new start-ups (whichsurvive for five years). She also noted similar findings to Geerts et al. about

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efficiency and turnover improvements, but also found that employment tendsto increase. It would be instructive to discover through this research thefactors that influence the success of transfers, as reflected in subsequentbusiness performance, since any policy interventions might then take theseinto account.

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2 SCOPING BUSINESS TRANSFER ISSUES

This part of the study allowed the range of issues associated with the successor failure of business transfer to be distilled, for exploration with focus groupsand in the surveys which followed. Evidence was drawn from an extensive

literature review and interviews with experts intermediaries in the businesstransfer process. Those interviewed (12 in total) included representatives ofmost major intermediary groups: brokers, bankers, accountants and businesssupport agencies.

2.1 MARKET OPTIONS FOR BUYING AND SELLING

Drawing on the broad view of commercial transfer presented in Figure 1, andthe analysis found in the literature and stakeholder interviews, the possiblemethods used in the commercial transfer of businesses are summarised

below.

Advertised sale.The seller advertises the business publicly, either inprint (in a specialist business transfer publication such as Daltons, atrade publication or the local press), online (mostly through specialistwebsites) or, less commonly, through a third party such as an estateagent. While this ensures that a wide audience is aware of the sale,the main disadvantage is that a publicly advertised sale may bedamaging, leading customers, competitors and potential purchasers toconclude that the business is in financial trouble. Initial indications arethat this method works well for certain types of business, in particular

micro retail, hospitality and catering businesses.

Sale through informal network. Instead of revealing that thebusiness is for sale to a wide audience, sellers may prefer to informtrusted personal and business contacts that they are selling, or password along a reasonably confidential grapevine to find a potentialpurchaser. Similarly, once purchasers have decided on a type of targetbusiness, they can make discreet inquiries to locate a match. Thisrestricts the number of potential matches, and may lead to a purchasersettling for a close, rather than perfect, match or a seller to obtain alower than optimal price. However, transactions costs can be lower

and the transfer may be accomplished relatively quickly.

Employee or management buyout. Rather than try to find anexternal purchaser, a seller may offer their business to (or beapproached with an offer from) the workforce. This circumvents theneed to find a buyer, but is mainly (though not exclusively) suitable forlarger businesses.

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Using a transfer agent. Brokers offer a complete service - obtainingvaluations, attempting to find a buyer etc. but their fees can often beexpensive. While some specialist business brokers and transfer agentsdo operate on behalf of purchasers, the majority represent sellers, for afixed fee upfront and/or a percentage of the final selling price. They

tend to use specialist transfer lawyers and accountants, leading to amore rapid and thorough process, but may struggle to find appropriatebuyers, due to their lack of specialist knowledge of sectors or individualbusinesses.

2.2 FACTORS AFFECTING TRANSFER

2.2.1 The range of issues

The survey of transfers carried out by Geerts et al. (2004) found that, onaverage, around two-thirds of entrepreneurs experienced problems withcommercial transfers, particularly with takeovers and MBOs. Difficultiestended to centre on financing and cultural issues, while legal issues, lack ofinformation from the seller, and unexpected shortfalls in finance were oflesser concern. It must be noted that these are the problems identified bysuccessfully transferred businesses so those which stop a transfer goingahead at all, such as those caused by a lack of information from sellers, areless likely to figure.

Van Teeffelen et al. (2005), studying employer organizations, agencies, SMEresearch centres and consultants in the Netherlands, found that amongstmost frequently cited problem was the lack of knowledge on the part of thebuyer, the seller, or both, particularly on financial matters and the valuationof the business. Complexity of legislation did not figure, implying it does notpose a substantial problem.

Geerts et al. (2004) point to the importance of the availability of risk bearingcapital, which current providers do not seem prepared to meet, at least to asufficient extent. However, the SBS Business Transfer Review (2005)submissions do not concur entirely, arguing that financing for taking over awell-established business is (or should be) relatively easy to obtain and thatthere are other factors which constrain the transfer market most notablythe prevailing attitude in favour of start-up.

Mandl (2004), looking at Austrian businesses, identified three key factorsinhibiting post-transfer success: a lack of specific planning; failure to use anexternal consultant; and a successors lack of experience, in terms of bothgeneral knowledge of the sector and specific knowledge of the particularcompanys work practices. She also points out that larger businesses aremore able to successfully meet the challenges than smaller ones, particularlyin sectors where the average firm size is fairly small (e.g. personal services).

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In sectors more reliant on technology (e.g. chemicals or publishing), the sizeof company is less pivotal.

2.2.2 Gender related issues

According to Marlow and Carter (2005), women are less likely than men to

consider selling their business, and to buy into or inherit a business.Womens businesses tend to be lifestyle-oriented, and more likely to beoperated from home (i.e. entirely dependent on owner-manager) and thusmore difficult to both value and to sell. Yet, despite conventionally lowvaluations (from banks and other lenders) for such businesses, they may beof greater value to other women, who also seek a lifestyle business, andMarlow and Carter suggest that policy should develop this angle.

Marlow and Carter examine whether there are gendered presumptionsabout female-owned businesses, noting that women tend to face greaterfinancial barriers, receiving around one-third of the start-up funding given to

men. However, there are sound business reasons why this may be the case:- women tend to be more risk-averse than men, they are more likely to useinformal sources of finance, such as credit cards, and to own fewer assets tooffer as security, leading to women asking for lower amounts of finance andbanks being prepared of offer them less.

While womens experiences are not homogeneous, these stylised factsclearly pose questions about the ability or willingness of women to buybusinesses, and the sort of business they may look for (particularly in termsof real or perceived financial barriers), and gendered characterisations on theparts of intermediaries, agencies and even female entrepreneurs themselves.

2.2.3 The importance of planning

Virtually every contributor to the SBS Transfer Review agrees that successfulSME business transfer is, in the majority of cases, limited by a lack ofsuccession planning and this is the only constraining factor for which thereis overwhelming consensus. The existence of an exit plan, and theforethought demonstrated by its existence, make a successful transfer morelikely. The lack of planning, fairly typical amongst sellers, often leads to anunderestimation of the amount of time required for selling, and the optimisticassumption that a sale can be achieved more quickly than is the case.

Sharma et al. (2001) and Kommers and van Engelenburg, (2003) examinedthe transfer process, from the perspective of seller rather than buyer. Interms of laying the groundwork for sale, they indicate that the outlook of theseller is key they have to be ready to sell and to formulate a plan - aprocess which (according to EC estimates) can take as long as five years.

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The importance of being prepared and recognising the need to plan is alsoemphasised by Martin (2005), who notes that many accountants clients didnot think about succession until some trigger a change in circumstances made it a matter of imminent importance. Such events often occurred toclients in their fifties, but lack of preparation meant the opportunity to

behave strategically and seek maximum possible advantage, have alreadybeen lost.

Some companies, wanting to achieve a good price, attempt to makecosmetic changes to their business practices prior to sale a process knownas grooming. This is described by one experienced transfer broker as oneof the least productive activities of accountancy practices. There seems tobe no correlation between the time spent grooming and the price paid oreventual success of the transaction, making the process a waste ofresources. One expert commented:

if you change your credit control because you think you can change the

numbers the buyer may have been able to do this better than you.You dont really get your money back on doing such things and thebuyer loses an opportunity for value-added gain and getting theirmoney back more quickly

How long and what form should planning take? The form a plan shouldtake seems fairly open. Some authors (e.g. Morris, 2005) suggest it does nothave to be a written plan - it may be fluid, unstructured and open to change;the process and preparation it represents are what is important. However,the amount of time allowed for planning does attract scrutiny: Risak andNagy (1999) find a positive correlation between planning duration and

transfer success. When the SBS Transfer Review asked contributors tosuggest ways to ease transfer, most proposals centred around an increasedprogramme of advice and support to SMEs and, in particular, the need for a5-year succession plan, accompanied by the resources and expertise tofacilitate this.

While not proof that stakeholders are pulling in opposing directions, there is alack of consistency on advice about how long it takes to prepare for sale,between those directly advising business owners and those researching andformulating policy. Government advice tends to emphasise medium-termplanning (in the region of five years), while business consultants, presumably

with an eye on commission, assert that with their assistance, all necessarysteps can be completed in less than a year.

2.2.4 Using intermediaries

Corporate Acquisitions Inc (2005) suggests the lack of knowledge amongstbuyers and sellers is the biggest obstacle. As most people go throughtransfer only once, early consultation with intermediaries, such as brokers,

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accountants or lawyers is strongly recommended. While this increases theassociated costs (a broker may charges up to 30,000 upfront, and 5-12%commission on completion) it is considered worthwhile given the increasedlikelihood of a successful transfer. Several propose that Business Link and/orother support organisations could take a more active role, and develop their

independent brokerage services, paid for by both parties.

Blackburn (2005) proposes that micro enterprises may find the cost ofintermediary services for transfer expensive and therefore try to minimiseuse often starting too late and thereby increasing the likelihood ofsuccession failure. Intermediaries may have to consider offering theirservices, at least initially, at a lower profit or even at a loss, to attract microbusinesses at prices they deem affordable.

2.2.5 Unique features blessing or curse?

There are specific characteristics of businesses and/or the ways in which they

are managed, which may facilitate or hinder transfer.

o Experts indicate that tacit knowledge, where a firm relies on theskills of particular people, is hard to value, making the businessdifficult to sell. On the other hand, if a business has an obviousgrowth path, based on existing capital assets and a solidmanagement and technical team, it should be relatively easy.

o A business with some form ofspecial or unique assets, as longas these are readily translated into commercial opportunities, islikely to be easy to sell, e.g. an armaments manufacturer, moving

away from their original line of business, but retaining approvals tosupply armed services worldwide, would probably obtain an easysale. This line of reasoning also applies to companies developinginnovative products or services, and accounts for the premiumattached to the valuation of such businesses.

o In a similar vein, in a niche market there may be very fewcompanies supplying a particular product and the sale of suchfirms should be straightforward. This is true even in decliningsectors, where the last remaining businesses are likely to continueproduction (and be of value) as long as some demand persists.

o

In sectoralterms, the most difficult businesses to sell are those indeclining sectors or in sectors with low barriers to entry. In the case ofthe latter, an entrepreneur would probably rather start a new businessthan buy an existing one, as only a business either with a unique assetor where there are unexploited opportunities for development would beworth more than the basic cost of entry as a start-up.

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2.2.6 Getting the offer right

The total amount of assets included can also affect smooth progress - if toomany superfluous assets are included (e.g. unnecessary land attached to aproperty for sale) a buyer may be unwilling to commit to the higher price.Alternatively, a business with low assets relative to turnover may represent

an unacceptably high risk to lenders.

Human capital-driven businesses, particularly small ones, are also difficult tovalue, a caveat that applies equally to IP-driven businesses, though somecontend that this difficulty is derived as much from the asset-driven attitudesof banks and lenders, as from the business itself. UK research shows thatmany small businesses do not register their intellectual property (Kitchingand Blackburn, 2003), and lack knowledge in this area (Bezant and Punt,1997) leading to problems of undervaluation and in establishing clarity aboutexactly what is being sold.

2.3 MATCHING DATABASES

Databases alone, without a full range of additional support measures, are notthought to work particularly well at matching buyers and sellers. Ourinterviewees expressed scepticism about their value, particularly those which(unlike Daltons Weekly, the UK market leader) do not charge for listing (forexample, those administered by government agencies). Some believe thatthe firms on offer are the less better; while others are easily sold, only thosewhich cannot find a buyer through other channels resort to such a listing.

In addition, in free matching databases, interviewees considered that, whilearound 80% of users were genuine sellers, and 10% potential buyers, some10% were fakes: an agent will contact a seller, pretending they have aninterested client, and offering to put the two in touch. Only when a deal isestablished will the agent actually attempt to find a potential buyer, aimingthen to collect fees from both parties.

Even discounting these concerns, matching databases have a relatively lowrate of success, with figures of between 3-10% quoted as the proportion ofsellers managing to find a buyer and complete a transfer. A detailed analysis(EC, 2006) of nine matching databases throughout Europe was carried out,

the majority had been in existence for three years or less, and listed acombined total of 11,000 businesses, equivalent to, on average, 0.2% of allcompanies in each country and around 7% of transferable companies.Many of those studied claimed a relatively high rate of success, typicallybetween 10-30% of businesses listed being transferred; but subject to thefollowing caveats:

o The small number of businesses helped.

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o The limited representation of micro businesses.

o Screening processes, listings are often limited to members of particular

business organisations, excluding certain firms at the outset.

o Success rates are often estimated by database hosts, rather than

based on hard data.o The lack of systematic follow up of transferred firms on post-transfer

performance or even continued operation, implies lists could be usedas sources for asset-stripping, rather than for transfer.

The same report (EC, 2006) recommends:

o Low initial entry costs to ensure a critical mass of diverse users.

o Impartial and trustworthy host organisation - probably a large business

federation.

o Systematic follow-up to determine success rates.

o Marketing and dissemination activities, aimed at smaller businesses, in

order to create a critical mass

o Diverse range of search criteria

o Anonymity

o Limited matching service (e.g. an email notification in response to abuyers saved wish-list) and filtering of out-of-date and poor qualitylistings

o Integration into a wider suite of transfer-related intermediary services

and advice and support provision.o Where large national commercial listings organisations already exist

(as in the UK), signposting these databases via a general transferinformation portal, rather than developing a rival database.

2.4 THE BORROWING ENVIRONMENT

Arbitrary rules and criteria

The attitudes of banks can exert a significant effect on the success oftransfers; regardless of the individual merits of applications for finance:

The targeting of the large corporate lenders is psychotic. They tell theirstaff that they want to lend as much as possible in tranches of 1m,but, by the way, here are the lending criteria which effectively leavealmost everyone out.... So [the staff] spend all their time looking forpeople to whom their bosses will let them lend.

Banks also tend to impose seemingly arbitrary rules, based on particularreference points, rather than assessing the needs of each application, and if

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rules are not (or cannot be) followed, they demand higher collateral. Thus, forexample, in an MBO in a relatively untried or unique sector, a bank mightrequire a larger team, with greater assets as collateral. This may discouragethe prospective buy-out, or the (imposed) larger team may actually proveunwieldy or unmanageable. One lender only approves loans where the

purchaser has an established track record in the same sector (backed up bytwo years of accounts) thereby excluding those wishing to go into businessfor the first time.

Favouring start-up?

Many argue that the financial environment reinforces the privileging of start-up over transfer. While the websites of most High Street lenders provideinformation on start-up, loans to buy commercial property, and businessexpansion loans, few mention the purchase of existing businesses, and nonedirectly advertise a specialist product for the purpose. While most do offer

loans for purchase, publicity concentrates on other areas, in particular start-up, possibly contributing to a perception that the latter would be easier tofinance than the former and, as SBS (2005)shows (mis)perceptions can behighly important determinants of the actions of entrepreneurs - often asmuch so as the actual facts.

2.5 USING INTERMEDIARIES

There is a range of intermediaries that can be consulted by both buyers andsellers of businesses. Of necessity, virtually all transfers (except perhaps thevery smallest) involve a solicitor to complete the legal handover of title to thebusiness and undertake due diligence, and the majority also involve anaccountant examining the books. While some lawyers and accountantsspecialise in transfer, most are generalists performing a wide range of legalor accounting services, and may rarely encounter a business transfersituation. Other intermediaries who can be directly involved in the processand influence its outcome include banks or other lenders, specialist businesstransfer agents, estate agents, and financial advisers.

According to a survey conducted in Germany, Belgium and the Netherlands,only 20-30% of acquirers hire a business broker, regardless of the type ofchange in ownership (Geerts et al., 2004). This is, by far, the lowestproportion among the range of different advisors; between one-half andthree-quarters use an accountant, bank, lawyer or tax specialist. Informalmeans of seeking a target business and/or the uses of databases (such asDaltons Online) seem more popular than employing professional specialists.

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Banks as advisers

Banks are currently more distant from the transactional parts of the dealsthan accountants, but would like to become more involved at earlier stages.Van Teeffelen (2005) concludes that bankers (and accountants) mostly takeinto account transactions at a relatively late stage in the process, and fail to

fully appreciate the importance of long-term planning in successful transfer.

Legal professionals

Lawyers are an integral part of transfer. They are needed to preparecontracts and to ensure that the deal which is signed and fulfilled isacceptable to their client. However, legal work takes many shapes andforms, and many lawyers are not transfer specialists which can impede theprocess. As with bankers and accountants, lawyers are usually engagedrelatively late in the process, when buyer and seller have already beenbrought together. Legal professionals need to be flexible in negotiating

terms and conditions of contracts; otherwise the selling party can easily walkaway to find a less intransigent buyer. The cost of legal services ranges from50 to 300 per hour but is typically around 200ph. Given that the processtakes up, on average, 10-20 hours, expected legal costs of transfer would be1K - 5K.

Accountants

Chartered accountants fulfil a number of statutory legal requirements onbehalf of small businesses and possess a great deal of skill and knowledgeconcerning business, particularly the financial dimensions. According to ourinterviewees, accountants operate more frequently on behalf of sellers than

on behalf of buyers. They also deal with relatively low numbers of sales around ten per year, on average, thus limiting their capacity to developexpertise. As well as only being approached a few times a year for suchadvice, many small practices are reluctant to get involved in broad-basedfinancial advice, often referring clients to local specialists.

However, if a chartered accountant assists in business transfer, there arepotential problems. Since accountants tend to serve only local markets,buyers seeking a business in a different geographical location may be lost asclients. Accountants may also be reluctant to inform clients of the full rangeof opportunities available, concentrating on those in the local vicinity for fear

of losing business thereby courting market failure.

Contributors to the SBS Business Transfer Review argued that use of anaccountant is vital, but only for financial services during the actual buyingand selling process (valuation, advice on tax issues etc.). Accountants, theyfeel, are not generally qualified to take a more involved role in negotiations,provide broader business advice or proactively match buyers and sellers.Martin (2005), in a full-scale review of accountancy practices in succession,

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finds that most practices do not offer standalone succession advice, butrather, especially for larger clients (with turnover in excess of 500,000),embed it in their normal business relationships, as part of a package,incorporating specialist, external sources of knowledge. For medium-sizedpractices, around 10-20% of advisory fee income is derived from services

related to succession advice, although this figure is substantially lower forsmaller practices or sole practitioners. Small clients are generally more likelyto use accountants simply for accountancy services, rather than seekingadditional advice.

In other countries, the role of accountants is broadly similar, but more in-depth; in a study of 40 Dutch intermediaries (a mixture of accountants andbank officials), van Teeffelen (2005) found that, in 75% of transfers in whichthey are involved, accountants co-ordinate the whole process. They tend towork from the perspective of the buyer, rather than the seller; i.e. ensuringthat the transfer is transparent, and helping to ensure the viable future of the

business.

Business brokers

In the UK there are no statutory licensing requirements for those wishing tobecome a business broker1 anyone can set up as a business transferintermediary. Our search indicated that there are no registries of brokers, soquantifying their number can only be through a search of business directories(e.g. Yellow Pages) andestimating the total number at best, can only be aneducated guess. On the whole, submissions imply that there are significantregional and sectoral variations in the numbers and use of brokers. Evidencesupplied to the SBS Business Transfer Review of business brokers (andtransfer agents) is mixed about how much business they get from SMEs, thesectors they are involved in or how useful they are.

Because brokers usually represent sellers, they have a strong financialinterest in completing the sale, leading to potential market failure, due toprincipal/agent problems. Therefore, the information provided by a sellersbroker should be treated with caution - an important caveat to potentialbuyers.

When a broker is contracted to represent a would-be buyer, they typicallyrequest a retainer of 1,000-30,000 and, in addition, a commission of 5-12%

of the purchase price on completion. The contract would specify the buyerstarget industries (typically one or two), types of businesses and locations.Once a potential acquisition is identified, the broker would contact the targetbusiness and such an approach can be attractive to a seller, avoiding thecosts associated with advisors and advertising if they were to initiate the sale

1 Nor are there any definitive terms for the practice the terms business broker, businessagent and business transfer agent are used in the literature and by focus group participantsinterchangeably.

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themselves. However, it should be noted that the use of a broker by apotential buyer to find a target business seems to be relatively uncommon,according to our interviewees, with most purchasers preferring to find abusiness by themselves. Therefore, brokers tend to make use ofintermediate methods (in particular advertising, both in Daltons and the

trade press) to find a purchaser, the costs of which come out of their fee.

A brokers network also exists, whereby buyers details can be forwarded toother brokers in particular areas of interest, alerting them to buyers needswhich may match the characteristics of existing sellers. Again, however, abroker needs to complete an acquisition to obtain the maximumremuneration, leading to a potential market failure.

2.6 TARGETING POLICY: SEGMENTING THEMARKET

While the SBS Transfer Review suggests an overall refocusing of policy totake more account of transfers and less of start-ups; Morriss (2005) analysisleads him to suggest that policy-makers should seek to add value to thequality of transfers, rather than trying to increase the absolute numbers,(which should be decided by the interplay of supply and demand in themarket), segmented them by type and addressed their needs in appropriateways. His proposed categorisation is fivefold:

(1) Form of disposition (internal transfer, sale etc.)

(2) Valuation/performance the exit of high-growth firms would be a lossto the economy, but they do tend to sell relatively easily. Policy shouldtherefore seek to ensure that the momentum of growth is continued post-transfer. If, for example, such a firm is absorbed by a larger enterprise,this could lead to the loss of jobs, products or important assets.

(3) Motives for transfer concentrating on push vs. pull motivations forthe seller. The former includes age, ill health, competitive factors etc.,while the latter tend to be driven by alternative opportunities opening up e.g. a proactive buyer, taking advantage of tax change etc.

(4) Key industries. For strategic reasons, the government may wish topromote transfers in certain sectors. Examples might be: national defence,preservation of culture, exploiting global competitive advantage,developing technology.

(5) Lifecycle. Rather than strictly in terms of the age of the firm, businesslife stages can be defined as: start-up; early growth to stability; rapidgrowth; maturity. Each stage has different implications in terms of transfersupport needs.

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3 FOCUS GROUPS FINDINGS

Sixteen focus groups were undertaken across the UK, principally with ownersof small and micro businesses. Groups of 5-10 participants each were held ten in England, and two in Scotland, Wales and Northern Ireland, with the

purpose of determining whether the transfer market operated differentlyacross different parts of the UK. Locations were chosen to reflect a diversityof settings, including major urban centres, market towns and rural areas.Membership of each group comprised those who had previously bought orsold a business, and those who were currently either considering or activelypursuing the purchase/sale of a business. Some intermediaries in businesstransfer were also included. The 115 owner participants varied in terms ofage, family/non-family business owners, gender (31% female) and businesssectors/legal forms. Details of these groups and participants are shown in Tables A1-2. The focus group discussion framework consisted of topicsidentified by the literature review and stakeholder interviews. It embraced

potential transfer obstacles, causes for concern and important positiveelements during the transfer process.

3.1 USE OF INTERMEDIARIES

It was found that intermediaries are considered to have an important role atthe very start of the transfer process, when the knowledge of both buyersand sellers is fairly rudimentary, as most have no prior experience ofbusiness transfer. Even for those who have bought or sold a businesspreviously, changes in rules and regulations may mean that their prior

experience is not as useful as initially thought. Therefore, they tend to relyon intermediaries to quickly bring them up to speed.

However, relatively few lawyers and accountants seem to be specialists inbusiness transfer, and some focus group participants have encountereddelays and confusion through using non-specialists. This has been especiallytrue of transfers involving larger sums or slightly unusual transactions, orwhere the business occupies a particular niche. For smaller, morestraightforward one-off transfers, participants were less critical ofintermediaries, and often preferred to stay with their own trusted advisersand professionals, not only because they knew the details of the business up

for transfer, but also because they assumed that the costs of a specialistwould be higher. In many cases of small transfers, clauses which would beregarded as essential in larger transactions were omitted, such as warrantiesabout the business for sale. In such cases, the solicitors job was almost justto rubber-stamp the transfer, which had been agreed on a friendly basisbetween the vendor and purchaser. If a specialist was sought, businessesoutside major financial centres had the choice between a small local firm,where they would often gain the services of a senior partner, or a more

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geographically remote, and more expensive, big city firm, where they wouldtend to get a more junior member of staff.

Solicitors, however, were also frequently identified as a main cause of delay,due to the time taken over due diligence, which clients are often not warned

about in advance. Frequently, it appears, only a vague timetable is specifiedat the outset, and unforeseen problems often extended the process. Thismakes the time and total cost somewhat unpredictable, especially for those both sellers/buyers and intermediaries - with no prior experience of transfer.

The bespoke nature of many transfers also increased the time and costdevoted to intermediaries, and meant that the experiential learning of thosewho had previously bought and sold was often of less use than theyexpected, especially if they were moving into another sector. Leasearrangements were singled out in several groups participants respondedpositively to the idea, referred to by business agents, of using highly

standardised US-style commercial leases as a means of simplifyingnegotiations. The desire for standardisation and streamlining also extendedto the seller compiling a selling pack for prospective buyers, detailingfinancial and other relevant information. Some objections to the latter idea,on the basis of cost, were voiced by micro business participants. It wasquestioned whether the pack, and the valuations therein, would beuniversally accepted given extra costs of seeking a second opinion forbuyers (and for sellers unhappy with their initial assessment).

Few participants had used business brokers, and there was some cynicismconcerning their capacity to deliver a sale and the need to pay upfront fees.There was also concern that a generalist broker would not necessarily havethe specialist sectoral or geographical knowledge needed to sell somebusinesses, and that they may recommend a less than optimal business to apotential purchaser, just to clear that business from their books. Participantsindicated they would be more likely to use a broker if some form of licensingor accreditation was introduced, although this would have to be government-backed, rather than through an independent association. In some sectors,(e.g. public houses) where there are clearly defined routes to sales andvaluations, business transfer agents are more highly regarded, as theprocess is more transparent, and their role in the transfer more established.

The main obstacle identified relating to banks related to their view ofindependent valuations. In participants experience, bank valuations aregenerally lower than those of other experts, affecting the amount they willlend the prospective purchaser. Some participants expressed distrust ofbanks, primarily because of the banks self-interest and risk-aversion, butrecognised that there were few other sources of finance for small businesstransfers. On the whole, however, finance for buying a business did notfigure as a prominent issue, with most participants finding that raising the

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necessary funds was relatively straightforward. Most relied on banks forfinance one group strongly recommended business angels, but surprisinglyfew participants had even heard of them. It should be noted that few FGparticipants had attempted to buy a business and failed. Lack of fundingmay be a more acute problem among this cohort, and may constitute one of

the reasons for failure of purchase failure.

3.2 ROUTES TO SELLING AND PURCHASE

Exit planning

Most owners admitted that they did not have a written exit plan, and, if theyhad sold in the past, this event was triggered by personal circumstances,rather than in response to strategic concerns. Common triggers included illhealth, a bereavement or a desire to have a more amenable work/lifebalance after years of long hours as an owner-manager. Younger ownerswere the most likely to have planned an exit, mostly having decided on thiscourse of action at start-up. Some participants were actively hostile to theidea of an exit strategy, stating that they would be wary of any companywhich had a written plan which included this aspect, partly through suspicionof the owner-managers motives, and partly through scepticism about thevalue of such detailed planning in a changing business environment. At best,most participants had only a vague idea of how they would go about sellingtheir business, and would deal with the matter when it arose. Support aimedat business planning for succession would likely have little take-up; mostowners prefer to seek advice only once they had firmly decided to sell.Grooming of businesses pre-sale tended not to be undertaken, as there wasrelatively little that needed to be upgraded or hidden. Most businessescould not envisage succession by their children or other family members, andvery few stated that they had considered selling to an employee thisseemed to be an option mostly limited to MBOs or EBOs in slightly largerbusinesses. Participants were not averse to the idea of an EBO in principle,but most could not envisage it taking place in their specific business. Most ofthose considering selling thought that the capital raised would substantiallyprovide an income for their retirement.

Timetables for selling/buying are rarely specified in detail in advance, andoften tend to drift out of control, due to the lack of planning or the suddennature of the decision to sell. For larger companies, there is scope for a moredetailed and schematic timetable to be devised, especially where thebusinesses involved are multifunctional and have several layers ofmanagement. Smaller companies, engaging in perhaps the only transferactivity of the owner-managers career, would be more likely to leave thetimetable in the hands of external professionals.

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Planning to buy

For buyers, it often seemed to be the case that the decision to buy wascatalysed by the awareness that they had the money available to purchase abusiness. They may have always had the idea in mind, but the availability offunds comes before the firm decision to buy, rather than vice versa.

Preparation time needed for purchase can be reasonably high - especially fora first-time buyer compared with a serial entrepreneur or a small firm lookingto add another business to their portfolio. One estimate was 4-5 hours pernight for 6 weeks.

Virtually no buyers or potential buyers indicated a preference for acquiring apoorly performing business with the intention of turning it around. Themajority sought a profitable, growing business. Indeed, several participantsnoted that, although being wary of an advertised business in the first place,they would be even more wary of an undervalued business - unless therewere clear reasons, such as the owner needing a rapid sale for obvious

personal reasons.

Marketing options

Once the decision is taken, sellers usually try to find a buyer by word-of-mouth, using local and/or sectoral networks (and many also use these samenetworks to obtain general advice about buying/selling). For small, genericbusinesses (e.g. corner shops), the market is mostly local, while someindustries (e.g. care homes) have highly standardised national transfermarkets, where valuations are calculated by a strict, well-known formula.

The role of sectoral networks in matching buyers and sellers is substantiallylarger in some sectors than others. Niche businesses (e.g. event planning,pottery), for example, are more likely to undergo vertical/horizontalintegration in a friendly merger or be taken over by a competitor, which maypossess the only people with the expertise to continue in the same line ofbusiness. The competitor is often a larger firm seeking to expand into newterritories. Public houses are also frequently sold via this route, as largecorporate chains buy-out independent owners. There was relatively littleconcern about this trend for most owners, the only real issue was the finalselling price. A small minority expressed concerned about either thesubsequent fate of their company or preserving a thriving independent SME

sector. In several cases, in fact, a speculative offer by a larger company wasa dream scenario, as it usually guaranteed a high price, and enabled a saleto go through with few obstacles.

Many participants outside London were opposed to advertising their businessfor sale, particularly if they could not do so anonymously; advertising was, onthe whole, most accepted among small independent high street retailers andpersonal services businesses trading away from city centre areas. There is

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some suspicion that businesses advertised are poor performers, which onlychoose this route as a last resort, although this stigma is less marked amongthose sectors mentioned above, and/or if a good reason is given for the sale(retirement, health reasons etc.). One owner noted that their sales haddipped when the business was for sale but had recovered when the new

owner was in place. Some had placed classified adverts, but mostly in thelocal press, rather than online or through a national publication such asDaltons Weekly. Few, if any, of these adverts had actually been decisive infinding a purchaser. Participants who were aware of Daltons mostlybelonged to those sectors which were more likely to advertise therein retailers, hotels etc. Other sectors (e.g. professional services, construction)were mostly unaware of the magazine, and awareness was also lower awayfrom its main geographical ambit (e.g. in Scotland and Wales), where, itcould be argued, sales tended to be even more biased towards local contactsdue to the lower business density. Thus, although the business agentsasserted that Daltons occupies a monopoly position, there may be scope for

a similar service for sectors/areas which tend not to use this selling route although it is worth noting that market failure often lies in areas other thanmatching.

Obstacles to sale

At least one person in every group identified internal disputes as an obstacleto sale. These involved, for example, acrimonious buyouts of partners anddivision of the proceeds of the sale among more than one owner. Suchdisputes can delay the sale, lower the selling price, and force up costs (e.g. ifeach partner hired separate solicitors). This suggests some role for anarbitration or counselling service, although participants largely resisted thisnotion, partly because of the perceived costs. The minority of owners whoadmitted they suffered some stress during the transfer, did so because ofobstacles, rather than any emotional stress inherent in selling a business. Ina relatively small minority of cases, sellers had encountered fraudulent orcriminal behaviour during the sale, or had been forced to sell due to beingvictims of crime.

The groups included only a small number who had unsuccessfully attemptedto buy a target business. Most participants asserted that finding a businessto purchase was easy. The groups were thus unable to throw light on anydeficiencies in matching mechanisms leading to failure to sale for lack of apurchaser. For the most part, the obstacles encountered by buyers weresimilar to those found by sellers, revolving around delays and cost overrunsby intermediaries.

Location considerations

On the whole, purchasers maintain an open mind with respect to the locationof a target firm. There is no evidence of inherent bias against buying a firm

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in a particular area and rational business criteria are applied to all potentialtarget firms. For example, the business context and climate of the area arehighly relevant for example, buyers would look in Llandudno for a guesthouse, not a professional services business. For generic small retail firms,the market was highly localised, but for niche businesses, or those with

unique IP or a well-known brand name, the location was largely irrelevant tothe buyer. Others noted that may not want to move outside their homeregion for personal (rather than business) reasons.

Local competition can also render it difficult to find a buyer; this was acommon experience among

Documents

The Operation of the Sme Transfer Market-uk-2007