Owner-managed businesses: The impact of COVID-19
In this podcast from Barclays Private Bank, two of our senior bankers, Edward Docherty and Shehreen Quayyum, discuss the impact of Covid-19 on UK owner-managed businesses. Together with corporate financier, Phil Adams of GCA Altium, and private client tax adviser, David Boyce of BDO, they explore: the impact of the crisis on fundamental business models; how valuations and buyers (including private equity) are adapting; possible future tax changes; and which sectors may come out of the crisis with stronger businesses, enhanced reputations and better exit prospects.
This was recorded in July 2020
See below for timecodes of particular discussion areas:
- 00:00 – Introduction
- 00:54 - How has Covid-19 impacted mid-market companies in the UK?
- 02:50 - The Private Bank is seeing some clients come out stronger. What is the panel seeing?
- 04:16 - When does the panel think buyers will return to the M&A scene? What are PE houses doing?
- 09:06 - What redundancy plans is the panel seeing? How are valuations being impacted?
- 12:03 - How long will it be until we see a broad-based recovery in UK M&A?
- 15:05 - What is the panel’s advice to entrepreneurs around wealth structuring ahead of a sale?
- 18:09 - Has the change to Entrepreneurs Relief impacted the appetite of entrepreneurs for business exits?
- 20:10 - Does the panel see any changes to CGT and Inheritance tax in the near future?
- 24:38 - How are businesses changing their models as a positive outcome from the current crisis?
- 27:23 - Which sectors have benefited from emerging new trends in consumer behaviour?
- 31:01 - What should clients be doing now to prepare for the post-Covid-19 world?
Nick Chuter (NC): Hello and welcome to the first of a series of podcasts from Barclays Private Bank. My name is Nick Chuter and I head up the team specifically catering to the needs of ultra-high network entrepreneurs in the UK.
With COVID-19 still dominating headlines well into 2020 there is no denying that the world is in flux, all the more so if you own a business. Today, two senior bankers within the team - Edward Doherty and Shehreen Quayyum - explore what the pandemic will mean for UK entrepreneurs.
To ensure all angles will be covered, they are joined for a fireside chat by Phil Adams, CEO of GCA Altium and David Boyce, Partner Private Client services at BDO. So, without further ado, I will hand over to Edward.
Impact on UK mid-market companies
Edward Docherty (ED): Phil Adams, you’ve been doing a bit market M&A for almost 25 years and have been CEO of GCA Altium for the last 10, so you are eminently qualified I think to answer the next question. How has COVID-19 impacted the mid-market companies in the UK that you and GCA Altium work with?
Phil Adams (PA): I think it has had an unprecedented effect. As you said, I’ve been in the market a long time. Thinking back to March, which seems an age away,
automatically there was for many companies the adjustment to remote working. Then, depending on the sector, obviously some businesses have been shut down, partially shutdown and other businesses in e-commerce, logistics etc. have seen this huge surge in activity which has presented different problems. It’s unprecedented times and very much on a case-by-case basis in terms of how and what companies have faced.
ED: David Boyce, you’ve got over 30 years’ experience at BDO providing private clients with tax advice in the mid-market space. In broad terms, how have your clients reacted to COVID-19, what have you seen?
David Boyce (DB): Thanks Ed. Similar to Phil, we have definitely seen a slowing down of transactions, either that being restructuring exits from the business. Business onus has been much more focused on keeping the businesses going and picking what reliefs they can and trying to get through what has been a pretty torrid time. So definitely a slowing down on that side.
I’m starting to see some sort of shoots of regrowth coming through. People have been holding off for some months but actually I think a resignation of ‘this may go on for six months’. Therefore, there are some transactions that do need to be done.
Can businesses be stronger as a result of the crisis?
ED: Phil, coming back to you, at Barclays Private Bank, a lot of ultra-high network clients that the companies that they own and operate are undoubtedly suffering due to COVID-19 and the lockdown. Interestingly we’re also seeing client’s businesses that are actually going to come out of this far stronger. Whether that’s financially or in terms of changed operating models. Is that something that you’re seeing at GCA Altium?
PA: Yeah definitely. We’ve seen a kind of increase in activity in some sectors like technology, cyber security, e-commerce - not necessarily in deals closing. We’ve done 40 deals since lockdown started globally, but in probably the last six to eight weeks, we’ve seen a real big increase in activity in certain sectors which are seeing quite a dramatic pick up in some areas.
It’s clearly overall not a positive picture but I think within pockets of sectors that there is a real increase in activity. There is a swathe of funding looking for homes and we are seeing the phones ringing a lot more than it was 2 months ago.
Private Equity House engagement
Shehreen Quayyum (SQ): Phil, many of our clients who are looking to exit, either partially or fully in either 2020 or 2021, realise that whilst there is a significant amount of dried powder waiting to be deployed, they have to be patient to return to market. When and how do you see the domestic and international buyers resuming their search and also where do the private equity houses fit into this buying landscape?
PA: Sure. I would say that there’s a supplier issue rather than a demand issue. I think that the funding and the buyers are there. The challenge is whether vendors are ready to go to market or not depending on what the impact of their business is, so private equity has never had more funding than it has now.
I think the challenge is, to do a transaction at the moment, it’s quite hard for anyone to buy a business unless they knew it already. I think what we’re seeing is private equity which have tracked businesses for years, not necessarily lots of years but a year or two, they know management, then they are very keen to proceed. I think running a new process and expecting a business in the US that doesn’t know a UK domiciled business already – expecting them to be a buyer I think is very unlikely.
What we’re seeing is lots of narrow processes, with three or four interested parties. Typically, they’re parties who knew the business already but they – it’s just being realistic about whether a buyer can transact if they are in a different geography. What its lending itself towards is trade buyers who have local presence and private equity, who have a presence in the UK.
But were seeing a lot of push for transactions and the last point on private equity is that they are very keen to deploy through their existing portfolio companies. They’re actually pushing hard because they see that as a safe way to acquire and potentially average down in the level of multiple they are paying for businesses.
DB: At BDO we are also seeing something similar to Phil in that generally evaluations are lower. Going back to there being a significant drop in stock markets back in March, which have picked up but not to the same extent and a massive impact on the economy. With GDP being down by more than 20% and the forecast being the UK economy will be down by 14% for 2020, these values are much lower.
Now it is sector dependant, as Phil said. There are certain areas that we’ve seen do very well. Technology and online retail have been good, but in general those values are down. At BDO, when we are looking at values, there are many ways to value a company but generally you’d be looking at profit being one of the most important components, and then secondly multiples. We would multiply that profit to give you a value.
Now in general, with the cautiousness in the market, and the problems we have seen from COVID, those multiples are generally down across all sectors. If you combine that with most companies having profits being reduced during the current time, you’ve got the double effect of multiples down, profits down and therefore those evaluations being very low.
So that’s why I think you’re going to see private equity get into the market while these values are low. They can pick up real deals but the purchasers, the vendors are going to be slightly cautious that these values are too low.
It does cause some issues in doing the valuations because you’ve got to look at much more information. It requires a lot more thought to try and value that business. You start to look at whether the effect is temporary, what the historical performance has been of the company and the quality of the financial information of the company in itself to try and get those values back up, if you’re looking for vendors.
But at the same time for purchasers, with equity they’ll be looking to work on current figures and really push those values down.
Redundancy plans and impact on valuations
ED: David that’s really interesting, I actually, and it’s good to hear that both you and Phil are seeing exactly the same thing in the market. What I would like to do is explore further in a little bit more depth, both of those things that you’ve just mentioned - multiples being down and profits being down.
I think it would be – just looking at profits first, it would be remiss of me not to ask the question of both of you as to what you’re seeing in terms of redundancy plans of mid-market companies in the UK once furlough ends? Obviously that has a massive impact upon the fundamental operating structure of the business and therefore the profitability and how that might be impacting the ability for buyers to come in and value businesses.
Phil is that something you want to pick up first? The potential redundancies coming down the pipes?
PA: Yeah, happy to but I think one thing I would probably just clarify about the market which I think is quite important is that we’re seeing quite a binary effect. So, we’re not seeing evaluations being hit. We are seeing either companies being capable of doing transactions because they are doing well and valuations are actually if anything going up, or companies have been hit hard in which case they are just not transactable so I think what we are going to see play out is slightly different.
Private equity we’re not seeing buying things for lower multiples. They are looking at different structures of deals, maybe giving vendors slightly less cash out. But, I think that for businesses that have performed, it’s a far more positive environment. For companies that have been hit hard then clearly it’s just not the right time for them to transact.
I come back to that sector piece: what we are seeing is that redundancies - we’ve historically done a lot of work in the travel sector. The travel sector has been hit very hard and ultimately that is going to play out with heavy redundancies, certainly in the short term with the thought that companies will begin to re-employ going forward. But there is, there really is quite a binary picture out there in terms of what we’re seeing.
There are sectors which are actively recruiting and are struggling to cope with demand and they’re the ones where the transactions are happening.
Broad recovery timelines
ED: That’s interesting, so it’s not a broad-based M&A recovery or even the beginnings of it, it’s very sector specific, is that what you’re saying?
PA: That’s certainly what we’re saying but we don’t really operate in the restructuring end of the market. We are very much focused on growth, but we are seeing a lot of activity for businesses, with software businesses, manage services, said e-commerce and logistics. Actually those areas have benefitted and there’s a lot of potential activity in there – we closed a cyber-security business a couple of weeks ago and an internet a hosting business about a month ago.
Both of those had seen really strong demand. It is really a kind of two-tier picture at the moment.
ED: That begs a question to both of you – perhaps you can pick up David - which is how long do you think it will be before we see a broader based recovery in mid-market M&A across sectors in the UK?
DB: From our side, again agreeing with Phil, it is very sector dependant. Obviously dealing with a lot of audits and tax advisory work within BDO we see the whole range. We see some companies that are really struggling at the moment but others just flying really with the change in market.
It really does just depend on whether you can have the flexibility within a business to change. Things like taking up the reliefs that were available: furlough is obviously important and lots of other benefits in delaying potentially VAT, just to keep the cash in the business, keep it looking attractive.
But it really is that sector part, so some businesses are really struggling and are needing to take all the help they can get and others just absolutely flying at the moment.
ED: That’s useful. Phil coming back to you and something you alluded to about the behaviour of private equity houses in terms of limiting, or seeking to limit, the amount of cash output for entrepreneurs. Do you think that will put potential vendors off from bringing the companies to market?
PA: I don’t think so. What we are seeing is just open conversations where in reality it’s an alignment of interest, so private equity owners are saying to vendors: ‘Look, we know you’re not going to take a massive hit on valuation because otherwise you might as well just hold onto your business. Therefore, let’s see if we can structure something that works when maybe there’s a little more a bit more deferred consideration, which gives you time for your business to recover. We’re happy to pay for that recovery.’
So, instead of taking 50% of your cash off the table you might take 25% and they’ll be a sort of deferred payment off the back of ‘21 or ‘22 results.
I think people are being pretty innovative because if vendors are not needing to do a deal, you’ve got to persuade them to do a deal. David will be far better placed to sort of comment on this, but what we have seen in the last week is a lot of conversations from entrepreneurs that I know just anecdotally are slightly nervous about what’s coming on the tax front, which I’m sure we are going to cover later.
It’s the front of the FT today - people are slightly agitated by what could happen to capital gains tax. I think you are seeing, I’m sure from your side and in Barclays as well, increasing conversations around what entrepreneurs should do and whether they should take action sooner rather than later if they can.
Wealth structuring ahead of a sale?
SQ: That’s really interesting Phil. Perhaps a follow-on question for you David – we all know that preplanning and well structuring is vitally important prior to an exit. At Barclays Private Bank we’d certainly help our clients think about this in the context of their future plans. With that in mind, what is your advice to entrepreneurs on well structuring ahead of a sale or liquidity?
DB: Thanks Shehreen. I think probably advice hasn’t changed. Whilst COVID is having a massive impact, you’ve always had a sort of sale process that needs to be followed to get the best from any deal really.
So that’s, if you can be a couple of years ahead of an exit, then you can start to get the structure right. You can look at things like entrepreneur’s relief and consider management incentives to make sure that the team are going to be there as you go through this sale or exit.
Then start to get that whole extraction strategy in place and, as Phil said, you consider cash and low note options, deferred consideration earn outs and everything else. Once you’ve started to get that structure in place you can start to get in readiness for a sale. You can start to make the business to look as attractive as you possibly can.
You might have various health checks done on the company, so from a VAT side, PAYE side, and making sure that all of those are in place and up to date so there is nothing that is going to put a purchaser off. You can then start to look at the valuations and, as Phil would do, start to look at target buyers to see what sort of value you are going to get from the company.
That’s before you even start to market the company, so you know exactly what you’re going to get, what’s likely to be there in the market from the money that’s there to purchase the companies. Then start to put almost sale provisions in place. You might do some vendor due diligence ahead of the game and start to see what offers you are going to get.
By the time you get to that sort of sale process, you are already there. The company’s looking really good, the balance sheet looks great, everything’s up to date in terms of compliance and then you can bring in the legal side to get the contracts sorted out. So, it hasn’t really changed that much. Now obviously it’s much more focused on people considering what’s going to happen to their businesses, but again I think you still need to go through all of those processes to get to a point where your business is looking attractive.
The taxation side is important. You need to be thinking about that the whole time, which is going to give you what your net proceeds are, which is the point where people will be looking to Barclays to invest that money. By the time you get there you should know the exact value of what your business is, what you’re going to pay in tax and what you’re going to have left at the end of it.
Entrepreneurs Relief and impact on potential business exits?
SQ: That’s a very good point David. You mentioned entrepreneur’s relief and obviously that has changed recently. Have you at BDO seen any implications of that change to the entrepreneur’s relief? I mean, it might be too soon to tell given lockdown?
DB: It’s early days, it is early days. Obviously the changes came with effect from this tax year, so April 2020 but just a massive change of going from £10million of relief down to £1million. Entrepreneurs relief obviously brings the capital gains tax rate from 20% down to 10%. On mid-sized businesses where you could be looking at businesses around the £10million level, now you could be paying not far off an extra million pounds in tax going forward.
It does bring forward that planning side of it. Now, again, we’ve always worked with owners to look at that structure of the company as it is and you might now want to move some of those shares earlier to– if you’re looking at a family business that might be ongoing through the family and been passed down - bring the adult children in earlier and give them some of the shares, so that they can use their allowances and their entrepreneur’s relief limits. Or even looking at trust structures, so you can pass assets into the trust.
If you’re not going to get entrepreneurs relief on the value of your company, you could be passing shares into a trust and a lot more into a trust than you would normally be able to post-sale and setting up that for future generations.
Whereas in the past, owners would have been very happy to pay potentially 10% tax, the fact that that has now doubled is putting some people off. The fact is that we are now starting to see the need to start structuring a little bit earlier and look at what is going to happen to that money post sale.
Changes to CGT and Inheritance tax
SQ: Sure. Do you see any further potential changes to the capital gains tax and potentially the inheritance tax that entrepreneurs should be taking into consideration in the future?
DB: I think there has got to be some tax changes at some stage. Last year there was lots of speculation certainly around inheritance tax and it was part of the manifestos for all of the political parties at that time. So that was almost certainly coming through. For some reason it was delayed.
I think that one reason was you had Brexit, you had an election in place. You had for the first time for a while a majority party being able to do their own budget so they held off for that.
Probably the plans were to have a much greater review towards the end of this calendar year but again with COVID, the summer statement was very bland in terms of tax – not much there. There’s a lot of money being paid out by the government, so at some stage you would think they would want to try and recoup some of that.
Capital gains tax (CGT) might be a good one to pick on because, again, it’s only chargeable when you have a transaction so it’s almost down to the vendor to choose when that is and capital gains tax rates still are very low even without entrepreneur’s relief – 20% compared to taking money out of the company as well as income at 45 or 47% or dividends at 38% plus capital gains tax rate still look very low so that could be attacked.
Inheritance tax is an easy one to pick on. There’s already been two consultations and reports done – the first one by office of tax simplification and secondly by an all-party political group which both had very radical changes proposed for inheritance tax.
ED: David, could I just explore a little bit further with you the CGT issue? At Barclays Private Bank a lot of our clients are asking us do we think that CGT rates will be pushed up to match marginal income tax rates? From the people that you speak to at BDO, is that something that could be on the cards?
DB: I think ‘could’ is the operative word Ed. It’s always very difficult. I think at the moment everything is speculative. If you’re looking round to see where government revenues will increase, it seems a fairly obvious one. I think inheritance tax may be ahead of the game. Capital gains tax has already been hit with this big reduction to entrepreneur’s relief.
It does seem that the revenue are very anti-taxpayers moving capital into regimes to get that rate down so it is an obvious one to be attacked. Whether that will happen again is very difficult because a lot of business assets around which can be impacted, but it seems a potentially high-risk one.
ED: So, a follow up question David, do you think entrepreneurs are potentially looking to move off shore in order to avoid what they see as potential tax rises coming down the pipes?
DB: There’s always potential moves. There’s a lot of anti-avoidance legislation these days for trying to move businesses abroad. Personally they could, but they have still got a raft of legislation that would tax them on their UK companies if they haven’t moved on that, revenue of tax properties within companies – there is a whole raft of legislation is to stop that. You’ll still have that and there is opportunity to do it, to move off shore, sell assets while you’re gone.
But in the majority of cases, the practicality of that is that you’ve got to be gone for five or six tax years to get those benefits and not come back to the UK. It’s a very hard decision to leave a place you’ve quite potentially grown up in and lived all your life just for tax reasons.
Change to business models because of the current crisis
ED: Phil, I wanted to bring it back to you for this. You know the fascinating question about you the upside, if I can call it that, of COVID-19 in terms of the businesses that you get to work with. At Barclays Private Bank we know that a lot of our entrepreneurial clients have had a fantastic capacity to react to changing circumstances and to profit from them.
How are you seeing mid-market companies in the UK change their business models, change their operating models, in order to profit and flourish in this changed landscape that we all live in now?
PA: I think the most obvious one which has been talked about quite a lot is just the move to online. What we’d seen in the last few years is actually a lot of online businesses had struggled to grow and I think a lot of businesses which are not pure on-line players have suddenly seen this quite dynamic growth within certain sectors.
So, for example, I was chatting to the owner of a wallpaper and paint business and they’d seen the most dramatic growth in profitability that they had seen - and this is a 100-year-old business - in the history of the business. People are, entrepreneurs are incredibly flexible and quick to move to address trends.
We’re seeing businesses that actually were set up for this. We’ve got a global business and one of the things when you’re talking to people, investors across say technology, what they are really excited about is, they have this description of five years’ growth or five years’ acceleration of trends that has happened in three months.
What you are really seeing is there has been an inexorable move towards tech and the use of technology. I think lots of companies who had set themselves up for that are now kind of reaping the benefits. Companies which are not able, haven’t been leveraging it fully, are now shifting and pivoting and working out what the new markets mean and in lots of cases seeing some efficiencies in terms of their own business models. I think that will play out over time.
I was listening to a Silicon Valley investor recently and he was talking about how it’s never been cheaper to set up your own business. I think entrepreneurs are shifting and lots of your clients will be looking at new areas and sort of exciting trends that they can look to leverage.
Sectors benefitting from new consumer behaviour
ED: Yeah, it’s an interesting point you make Phil and I wanted, if I may to just delve a little more into the issue of sectors. The sectors that are going to come out of this as winners and both of you guys have touched on this during this podcast.
At Barclays Private Bank, the trading companies of some clients are undoubtedly suffering. I’m thinking of hospitality and leisure. I’m thinking of hotels.
You mentioned travel and some of these businesses are quite simply crushed. There are other clients that we work with that are seeing their businesses do fantastically well. I’m thinking of companies with internet sales components, payments businesses, some tech businesses. It’s very easy to just use that word ‘tech’ as a catch all, but what are you seeing Phil in, perhaps not just in the UK - I am conscious that GCA Altium is a global business as well.
Which sectors are the winners, which sub-sectors look as though they are going to be the winners?
PA: I think it’s software. It’s cyber security. It’s online retail. However, I think one interesting point, David, which I think will play out is that – it’s not happened in M&A yet but I strongly believe this will happen - is that a lot of investors are latching onto the fact that in the toughest sectors, there is going to be a survival of the fittest and that actually there is a big opportunity for companies who can who can ride through this. People are looking at the travel sector and people are looking at the restaurant sector.
We’re looking at transactions at the moment that I think will probably be put on hold, but there are investors who are saying that, ‘we know it might go on for another 18 months or two years or whatever, but ultimately there are going to be winners and actually the loss of competition in some sectors is going to be a big opportunity’.
There’s no doubt that we are seeing the real ‘deal activity’ is in software managing services and business services. There’s some companies that I know that kind of provide HR services to SMEs. They are having a fantastic time at the moment because people are looking at health and safety issues.
Within the wider negative impact of the pandemic, there are these sub-sectors that are growing, but also for lots of our clients and your clients, there will be opportunities coming through the other side by this survival of the fittest. Through that a lot of companies are also looking at their competitors, and again it hasn’t played through yet, but I think there will be insolvencies.
There will be opportunities to buy up competitors in sectors that are perceived to be more difficult at the moment. There is going to be this big prize for the companies that come through.
ED: Are you seeing that David?
DB: Yeah, absolutely. I think even within sectors, even some sectors where they are struggling those companies have done okay and have been adaptable. [They’ve] changed their processes everything else and are looking good within those sectors. Even sometimes averaging those sectors where others are struggling, they will have a premium you know?
They are businesses that look as if they have got longevity in them, that have got a good business plan, even in the face of COVID and disasters – they’ve still got a longer business plan and a balance within their business that will take them forward.
Preparation for the post-Covid-19 world
ED: And a question from me to both of you, how long do you think we are in this for and what should our clients, your clients be doing now in preparation for that point of time when this is all over?
PA: I’ll go first. I think we’re almost learning as we go. There was an assumption in March that it was like a three-month lockdown and then everything would go back to normal. I think people are increasingly of the view that we are not sure what normal looks like. From a healthcare perspective, listening to some of the experts etc., I think the best-case scenario it that it could be until you have this kind of herd immunity concept via vaccine or people having been infected. We are probably a couple of years off that having a real impact.
The additional point is the behaviour change that happens during that period means that going back to how it was pre-March is probably never going to happen fully. Being in a position where you can look beyond COVID as a couple of years away, I think people are now dealing with a new normal and adjusting to it quite quickly as sectors open up.
DB: I think from my side Ed, at BDO and coming back to my private client side, our advice really is to the underlying owners and shareholders is to start to plan early. Again, it goes back to what we’ve always said but I think now people have got a sort of real reality of their own mortality. They’ve got to start sorting out their personal finances.
You’ve had a decrease in entrepreneurs’ relief. So, when you go out the other side, quite separate from your business, you’ve got to be planning ahead how you’re going to exit – whether that will be through your family, through the current management structure, through a third party and starting to put the structure in place now for your personal finances. If you own a business or you’re involved in a business – what that’s going to look like post COVID? How you are going to exit that in the future and getting that structure right?
ED: On that note, Phil Adams at GCA Altium and David Boyce at BDO Private Client tax, thank you both very much indeed for a fascinating insight into the UK mid-market and stay safe.
NC: I hope you enjoyed our first podcast and my thanks to Edward and Shehreen for hosting today's chat and as well to fill Phil Adams GCA Altium and David Boyce from BDO for sharing their views.
The world may well be in flux, but we at Barclays Private Bank are here to help you navigate the uncertain and unchartered waters that ultra-high net worth entrepreneurs are currently facing. Collaboration begins with a conversation, so to hear more to or speak to one of our private bankers please visit: privatebank.barclays.com. Thank you.