Small and medium-sized businesses are not adequately prepared for their business succession: only 10% of owners have a formal, written succession plan; 38% have an informal, unwritten plan; and the remaining 52% do not have any succession plan at all.
The avalanche of Baby Boomer business owners reaching retirement is triggering the world’s largest transfer of wealth. As more and more businesses are put up for sale, the chances of achieving an optimum price for the business will become more difficult.
For most business owners, the business represents a lifetime of hard work, and usually constitutes a large percentage of their wealth. A successful sale of the business is often critical to their financial security and a shortfall in business value may greatly affect their desired standard of living.
Few owners, however, have an objective understanding of what their business is worth, an understanding of what drives its value, or an understanding of the business sales process.
You would therefore assume that they would put a lot of thought and planning into succession planning. However, the statistics are surprising. A study in 2008 carried out by the Ministry of Economic Development and Massey University highlighted that 34% of owners intended to exit their business in the next 5 years, and 64% when that was extended out to 10 years (in line with International research).
Asked about their objectives when exiting their firm, 58% of the owners indicated that they were thinking of selling their firm, 36% would like to pass their firm on and 7% are intending to wind the firm down and close it. The most common reason for selling (70%) was to generate funds for retirement.
What is Succession Planning?
Succession refers to the transfer of ownership, and planning is about preparing for that event. Every business will undergo a change of ownership at some stage, whether it is planned, or triggered by an event such as ill health, a partnership dispute, key staff or major clients leaving the business, or there may be a sudden realisation that this is not what they want to be doing anymore.
What Does Succession Planning Involve?
- Strategic decisions by the current owner(s) on their objectives for exit
- A formal, independent business valuation
- Identification of potential successors/purchasers
- Conduct a pre-sale review of the business
- Plans to maximise the value of the business before sale
- Handover issues/transfer of skill and knowledge
When Should Planning Start?
A good succession should allow 3-5 years before exiting, depending on the option chosen. If the exit strategy is to get family or management to buy in, it may take longer if a gradual sell down over time is required.
Reasons Given by Owners for Not Planning
There are many reasons owners give for not planning ahead that include:
- Too early to make a plan
- No time to deal with the issue
- Don’t want to think about leaving
- Reluctance to think of death/sickness/accidents/relationship breakdown
- Handing over the reins/ownership and control
- Retirement reluctance
- Too complex
- Can’t find adequate advice
- Conflict with family
- Conflict with employees
The single largest barrier to the successful transfer of ownership of a business is the emotional unwillingness of the owner(s) to consider the future, and the consequent belief that exit planning can wait.
What are the Exit Options?
When owners start to think about exiting their business, there are several options to consider:
- Sell to an outside third party. By selling the business you are able to translate the value of the business into dollars and no longer have to worry about the business. It usually achieves the maximum amount of cash at closing; however the challenge is whether the owner can walk away from their business, and lose a meaningful part of their lives. A lot of owners also worry about the effect on their employees with jobs or career opportunities at risk.
- Sell to an insider including: o Sell the business to key employees. The advantages and disadvantages for this option are essentially the same as transferring ownership to family members. o Sell to employees using an Employee Stock Ownership Plan. The advantages are similar to transferring to a family member however the owner converts the business into cash, and does not need to remain involved with the business. The disadvantages are that often the owner’s assets may be tied to the business as collateral for the loan, and the buyout often involves an element of pre-funding by the owner’s business.
- Sell to one or more co-owners. This transfer involves essentially the same advantages and disadvantages as a sale to family members.
- Transfer the business to a family member. This allows the business to stay within the family, perpetuate the culture and mission, and allows the owner to remain involved. The disadvantage is the increased financial risk as usually the family members are not financially able to pay for the business, so the owner remains tied to the future financial performance of the business. They also usually receive little cash on the transfer which is not ideal for an owner needing the finance for retirement. It can also cause family issues trying to decide how to treat all children fairly and equitably.
- Retain ownership but become a passive owner. This is only an option if there is a strong management team in place. The owner never permanently leaves the business, continues to experience risk with ownership, and receives little or no cash
- Engage in an Initial Public Offering (IPO). This option often excites owners as the valuation of the ownership interest is usually higher than in any other form of transfer, and it brings cash injection from a pocket other than the owners. However the IPO is not a cash event and the owner’s interest is exchanged at closing for shares of stock in the acquiring entity and is typically prohibited from cashing them in until a defined period of time passes. When the owner is allowed to sell, the share price is often significantly different from the value at closing. Often the owner is required to stay on for a while and be accountable to shareholders, analysts, the Securities Commission, and more.
- Liquidate. This option provides speed and cash, however it has huge disadvantages and arises because the owner has no alternative exit strategies in place. There is minimal cash, significant effect on employees, and tax consequences.
The owner’s objectives (cash needs, future desired owner or exit timing) provide parameters to evaluate the various exit options. If there is more than one owner, getting consensus on exit strategies may narrow the options available.
Business owners should always work towards making their business ready for sale, so that if events occur that necessitate a quick sale, such as health issues, marriage or relationship breakdowns, accidents, or even death, the business should still sell for an optimum price.
By maximising the value of your business, you will be in a far better position to choose among the many different exit options.
For some business owners, they are the greatest risk to their business due to their limiting attitude of “she’ll be right” way of thinking.
Planning to sell a business is not the same thing as being able to sell it when the time comes to put the plan into reality. Effective succession planning allows you to be in a position to make an informed choice about your exit, and not having the choice imposed on you.
The key to success lies in commencing the succession process early and choosing the right exit option to suit your circumstances. Those owners who do this, will likely maximise the sale price, and have more control over the process.
Planning your next move is vital for any business owner. It means preparing your business for the next phase of its life, and just as important, yours. We can help you get started on your succession planning journey. To arrange an obligation-free succession consultation for you and your business, contact us