Why the Irish family business sector could be 'cleaned out' in a generation

Selling to a foreign buyer is often the best option for indigenous firms, experts say.

By Killian Woods Reporter, Fora

BUSINESSES CAN FORM part of the seemingly timeless identity of a street, town or city, but the last few weeks have been a stark reminder that these outlets can also disappear in an instant.

At the beginning of the month, Liam Ruiséal’s bookshop, a landmark of Oliver Plunkett Street in Cork, closed down after 100 years in business, while this week Waltons also shuttered its iconic George’s Street music shop.

Natalie McCambridge, the co-owner of the Galway grocer McCambridges, says as an owner it’s scary to see other family business stalwarts go to the wall.

“You drive through a small town these days and you see a lot of empty premises, and you know they were once thriving family businesses,” says McCambridge.

“Family businesses bring a sense of individuality to an area, there is only one McCambridges whereas there are Centras and Spars all over the city.”

McCambridge and her brother Eoin inherited their family business, which was set up in the 1920s, from their father.

She says the idea of succession is something that plays on their minds, and it can be difficult to see where the next generation of owner-managers will come from.

“Between us there are six grandkids, but none of them are showing any interest at the moment in coming into it.

“None of us were ever forced into it and I would hate to think any of the next generation weren’t in it for the love of it. If nobody wanted it, selling would be our last resort. But I know none of us would like to see that.”

3752431 McCambridge's store in Galway
Source: McCambridge's

Paul Hennessy, the head of PwC’s Irish family business advice practice, says it has become common for families to second-guess whether they want their children to take over a business – which is leading to a lot more sell-outs.

“They’re thinking is the next generation actually ready for this and will they be able to take on the stuff they need to deal with in, let’s say, a recession. Families are thinking do they want their kids to have to got through it all,” he says.

It’s a worrying trend that Hennessey thinks would have a drastic effect on rural Irish communities if more family businesses either close down or sell up.

“Family businesses bring commerce to parts of country it wouldn’t naturally go. Family businesses really support communities. Just look at hurling and GAA sponsors, pretty much all are family firms because they’re of the area.”

Selling culture

The shift in mindset from succession to selling is not a new development, according to Bernard Doherty, head of tax at Grant Thornton.

He says the trend is being reinforced by a tax and succession system that has been penalising indigenous small- and medium-sized firms for a long time.

He’s far from alone in this thinking. Last week, Fora reported that Caroline Keeling, the head of major Irish fruit supplier Keelings, wrote to Taoiseach Leo Varadkar and ministers to call out the state for having no vision for family businesses.

“The tax system is so prohibitive that the owner managers can get no value out of the company except in income tax at 55%,” says Doherty.

“If you’re taking out a salary of €200,000 and paying €100,000 in tax, you’re not really getting the value.

“The income tax rate is so prohibitive that selling is considerably more attractive. If some international player comes along and offers a cheque for €25 million for the business, you pay capital gains tax on the first 10% on the first €1 million and 33% on the balance.”

Fergus McArdle, who sits on the boards of a number of Irish companies such as Height for Hire and Horseware, says the tax system means it’s very difficult for a family business to last three generations.

“If it starts off with generation one as an acorn and then it grows into a small tree, by the third generation hopefully it’s a large tree – but by then you have to pay a mountain of taxes when passing it on.”

He says there is some tax legislation that provides asset relief during succession, but firms are penalised heavily when taxed on property deemed to be non-business assets.

“Let’s say you have a business worth €10 million of which €2 million are non-business assets and €8 million is business assets. The €2 million could generate a tax liability of €700,000.”

According to Doherty, Irish family businesses often have to sell a chunk of their businesses to pay these taxes. When family firms are backed into a corner in these situations, third-party financiers know they can make certain demands.

“The funders know they’re in a very strong position. And therefore they’re looking for a slice of the equity, more control and looking for seats on the board.”

Doherty adds if Irish companies had better access to funding instruments like mezzanine debt and convertible debt – both hybrids of debt and equity finance - then family businesses wouldn’t be under so much financial pressure to sell out to a third party.

pwc 1 Results from PwC's 2016 family business report
Source: PwC

Lack of planning

One Irish family business that has managed to stay solely in the family for decades is Donegal retailer McElhinney’s, which is now run by Martin McElhinney and owned by his father.

However succession is on the horizon, a topic which McElhinney says many family businesses don’t even like to raise.

“A lot of the times, I think what happens when the time comes, it’s the first conversation that there has ever been had about it.

“People in family businesses don’t like talking about that. I think it’s just human nature, you like to think of having those people around.”

According to McArdle, getting family members to the table to discuss succession is a challenge because they often don’t feel they have the time for the complicated process.

“Planning needs four to five years because you need to understand what assets are in the business and whether to get rid of assets that don’t qualify for relief.

“But if you’re doing that, you might not be concentrated on the business, and if you’re not doing that people feel they’ll drop stitches.”

The lack of planning is something the DCU Centre for Family Business is trying to address, according to Dr Eric Clinton, the centre’s director.

“We’re 20 years behind US for educating family businesses. If you look at all the major universities over there, like Harvard, they all have centres of excellence focused on family business.

“Every business school in Ireland teaches about finance and the other core principles but they don’t teach anything about family business. DCU was guilty of that as well until recently.”

Based on the firms that have attended the centre’s events, Clinton says the family firms usually have similar issues.

“They all think you won’t understand their unique problem, but it usually comes down to a succession issue. Succession is relatively easy with the help of accountants and lawyers and a straight-forward transaction. But talking about it is tough.

“Talking about retirement and the fact the older generation won’t be around forever is tough because it can sound quite morbid.”

3115168 Martin McElhinney
Source: McElhinneys Department Store

Eroding away

Considering the attitude to succession, Doherty says it’s not hard to fathom a situation where Ireland’s family business sector could erode quite quickly – even over a generation.

“If you look at it, the model in Ireland now is build and sell, build and sell, build and sell. You used to sell to Irish domestic purchasers, but now you don’t – it’s international purchasers, being funds from the UK and the US.”

He adds that with the economy already quite dependent on foreign direct investment, in one generation an even larger chunk of the Irish economy could be foreign-owned.

“Where does that leave us in terms of controlling our own destiny? The decisions about a company in Monaghan, Galway or wherever will be made by somebody in a pin shirt and cufflinks looking at a desk in London.”

It’s a bleak outlook on where the family firms sector is going, but Hennessy doesn’t subscribe to it.

“You could make that comment about the sector at any stage over the last 50 years, but family businesses are resilient. I don’t think it’s as bleak as saying give this a generation or two and we’ll be cleaned out.

“Some family business owners come to the point where they want to realise the value of their business.

“If you have family members who want to do something else, it’s sensible to sell it to create the capital and with it, sons and daughters can start their own small businesses.”

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