Tue, JUN 28th, 2016
This article is for all business owners out there. You’ve spent the last several decades deep in the trenches. At first it was a real struggle. “Will I make the next payroll?”, “what if I lose that key customer?”. Then roots began to take hold. Your customer base expanded, your business processes solidified. Employees were added to back you up. The growth continued and your team grew broader and deeper. Each day you arrive at the office motivated to continue the project you began decades earlier: your business.
Yet, somewhere in your mind the thought arises that you need to plan for a future without you pulling the levers of control. You need to plan for your succession. If you are like the vast majority of business owners, you’ve done nothing in this regard – less than 30% of owners have a written succession plan.
We are not just talking about a handful of companies: over 95% of the businesses in the country are privately held – ranging from sole proprietors to multibillion dollar conglomerates. These private companies create 45% of our nations’ GDP; in fact 175 of the 500 largest companies are family owned. Yet, only 28% of family businesses have a succession plan while over 50% of small business owners – defined by the U.S. Census Bureau as firms with fewer than 500 employees – are over 50 years old. Despite this lack of planning 78% of owners intend to sell their businesses to fund their retirement. Surprisingly, 71% of business owners over age 65 intend to continue working indefinitely.
The most common succession plan is a vague notion that you’ll give the company to your kids. How realistic is this? In 1900 families on average had 3.5 children. Back then half of the work force was engaged in agriculture and an additional significant percent was involved in a labor intensive family business. In that environment it was likely that at least one of the children would demonstrate the attitude and aptitude to take the reins – and support their parents in their waning years. In 2006 the average household had 1.8 children and the effort and expense required to successfully launch them in our economic system is much greater. College is often in the picture. Graduate school is also a distinct possibility. Often the child’s career path does not align with the family business. So, if it’s not a slam dunk that the kids will take the business over, why don’t owners get serious about succession planning?
Succession planning requires business owners to face the uncomfortable reality of mortality. It also causes a reassessment of position in personal family structures, within peer groups, and larger communities. In many cases your identity as a founding business owner is closely wrapped up with your firm. You feel needed – essential in the lives of others. “I’ll get to succession planning when I have time” remains your dominant planning technique.
How can you get motivated to plan for your eventual exit? Focus on the same factors that helped you lead your company to success: control, choice, value, risk, and taxes. Let’s break these down. Succession planning allows you to have much greater influence on the future of your company. Devising a plan offers the opportunity for you to have greater control and choice in how the succession will impact various parties including sellers, buyers, employees, customers, and your community. The value you’ll likely receive in a planned succession is far greater than what you’d get in a forced sale or transition. Planning allows you to imprint your values on the transition. What is more important – maximizing the dollars received or ensuring long-time key employees, customers and the community benefit from the continuation of the business? What’s the appropriate balance between such competing objectives? A thoughtfully planned transition allows you to decide. Don’t forget that a solid succession plan greatly reduces risk for both you and the ongoing success of the enterprise. Finally, a thoughtful plan can go a long way toward reducing the tax bite that’s often a big factor in an ownership change.
Succession Planning is easy. Identify your goals, determine how to best meet those goals, and implement your plan. Easy yes – but far from simple. Let’s break this down. In phase one envision what you want and take stock of what you already have. This means a thoughtful assessment of the future you want for yourself, your family, and your company. Critically, envision how the company will continue to succeed with you no longer there.
Phase two involves protecting and growing your assets, institutionalizing the company culture and leadership, and building resilient business processes. It requires a clear assessment of the roles you fill in the organization and a clear analysis of who can take over those roles. Replacement management may be members of your existing team or may require bringing in new talent. The transition almost always requires a multiyear mentorship as the new leadership team learns the culture, core competencies, and customers of your enterprise. To maximize your control, choices, and value, and minimize your risk and tax bite the process needs to start well in advance of the transfer. An internal succession may take as much as a decade to execute successfully.
How should you handle an unsolicited offer for your company? First and foremost reach out to your team of advisors. Initially they will help you determine whether an internal succession is feasible. If not, and if the business is significant enough, they will most likely urge you to retain a quality investment banker whose role it is to help you structure your business for sale and identify strategic buyers who will place the greatest value on what you’ve created. A seasoned investment banker is extremely valuable. In one typical instance an owner received an unsolicited $12 million offer for his company. He realized he was ready to sell and, as his financial advisor, we encouraged him to hire a banker who knew his industry rather than take the first offer. He ended up selling for over $30 million.
A word on the Letter of Intent (LOI). Seller misunderstanding of the LOI is the biggest single factor that can cause transactions to fail. The LOI outlines the best possible deal the seller will achieve and signals the opening of a comprehensive due diligence process. The buyer will be seeking out any aspect of the business that is not as was represented and will insist on a reduction in price to compensate for all that are found. It’s critical to be sure all your business process are clear, clean, and concise before signing a Letter Of Intent. To be crystal clear – the time to have a skilled attorney on your team is BEFORE you sign your letter of intent, preferably months or even years before.
Another important insight is that sellers can normally dictate price or terms – but not both. Typical sellers will focus on the highest possible price. However achieving that top line number likely means accepting some ongoing risk. Perhaps the deal includes some seller financing with a recourse option if the terms of the debt aren’t met. Do you really want to foreclose on the business that likely has been poorly managed and may have lost critical staff in an effort to salvage your retirement dreams? Probably not. Be aware of this tradeoff as you structure your transaction.
You’ve made it through the article; congratulations. But what’s going to motivate you to act? Circle back to the benefits of succession planning – increasing your control, choice, and value while decreasing your risk and tax bite. Now pick up your phone, open your e-mail, or pound out a text and reach out to your professional team and set your succession planning process in motion!
John Bird, CFA®, CFP®, MBA
President, Principal and Co-Founder
Albion Financial Group