Question: What do I need to consider as I think about selling or transferring ownership in my business?
Answer: Planning for the exit from your business is a critical step that all business people need to pursue. It may surprise you to learn that family businesses really struggle to survive through multiple generations. Surveys have indicated that only 30% of family businesses survive to the second generation of ownership, 12% to the third generation and only 3% to the fourth generation. Why? The main reason is that few owners have a documented succession plan, although everyone will exit their business, planned or otherwise.
There needs to be a plan for seamless transition. Business owners don’t plan their exit because they don’t want to think about a life without the business, or they feel they are too busy to address this key issue, or perhaps they don’t think they have the resources or access to resources to help them. Also, it can be an uncomfortable conversation to have with family members, partners, key employees or potential buyers.
So, what is succession planning? Many view it is an exercise to identify who is next in line for key positions in the organization. But true succession planning, according to Entrepreneur Magazine, is “the process of planning for the day a business owner decides to step down from their leadership role in the business.” It must be a written plan. It is not just a plan for when the owner wants to step down, but also has to address when the owner/leader might need to be replaced due to an unplanned event.
For a small business or family owned business, it is not just about role assumption but has to address ownership structure. The big question that needs to be answered in succession planning is who do you want to have an ownership stake, and how will that change in ownership ultimately be executed? Remember, all owners of small businesses will ultimately leave their businesses, either voluntarily or involuntarily. Having a succession plan ensures that the owner(s) have control over how it transfers to the next generation of owners and leaders.
Succession planning takes the same path as launch, operating or marketing plans. It answers the who, what ,when, where, why and how. What are the current owner’s personal and business goals – what do you want to get out of the business when you depart? Who are your successors? Choose who you want to take over management, and define the process through which they will be prepared to assume the role. Who will own the company? Define their roles and percentage of ownership and leadership. When and how will the transfer take place? Identify where the funds will come from to buy you out. What tax implications are associated with the plan? How will you communicate the plan to those affected by it (family members, key employees, trusted advisers)?
Fundamentals: Know all the options available to you. Assess the pros and cons of each option. Your goal might be to transfer ownership to a family member, but does that also include management, or is there a separate strategy for management/leadership succession? And does the family member have the desire and capability to manage the business? It may be that the best management successor is one of your key employees, as opposed to a family member.
Since a part of the value you realize is likely to depend upon the future success of the business, you should be sure to identify the right manager to succeed you. When thinking about a successor manager, do a skills//knowledge assessment and determine what “holes” in their experience need to be filled to take on the new role, as well as a timeline for preparation. It is never too early to prepare succession development.
Know the true value of the business: According to Warren Buffet, without a true valuation of the business, you are flying blind when planning your next steps. Get a professionally prepared valuation of the business so that you have a realistic sense of its worth. Just like any other plan, succession plans needs to be reviewed periodically by you and your trusted advisers to take account of changed circumstances.
What are the options available to an owner in exiting their business? While companies can go public or create an employee stock ownership plan, these are rarely viable options for small businesses. The more common exit paths for small businesses are giving it to a family member, selling it to an outside buyer, management buyout or liquidation.
Giving the business to a family member(s) creates a family legacy, but is a noncash transaction. One risk is that the owner never really exits the business due to continued financial dependence. Funding ownership retirement must be addressed in the succession plan if this option is entertained.
Selling to an outside buyer gives the owner the most dollars at the point of sale, but to effect such a sale an owner is likely to be forced to share key elements of the business to competitors. According to John Leonetti, author of “Exiting Your Business, Protecting Your Wealth,” the sale of a business to an outsider happens only 20% of the time, so an owner needs to prepare a plan that considers all other options.
Management buyout provides a smooth transition, since the buyer knows the business details, both its strengths and weaknesses. The seller, however, gets little cash at closing, as such transactions are often seller financed. Current ownership retirement security thus becomes dependent on the continued success of the business.
Liquidation is the most common way an exit from small business occurs – estimates are that this happens as much as 40% of the time. This alternative occurs when owners fail to plan their exit. Forced liquidation occurs when something unexpected happens, such as the death or disability of the owner, with no succession plan in place. And, of course, it usually leads to the worst financial outcome for the owner.
Part of any business owner’s planning strategy needs to focus on what will happen to the business when the owner is no longer willing or able to manage the going concern.
Look for Step 2 in planning the exit of business ownership next Sunday.
Contributed by Marc L. Goldberg, certified mentor, Jim Dannhauser certified mentor, and Bob Mauterstock, SME, SCORE Cape Cod & the Islands. Sources: “Simple Steps for Exiting Your Business,” SCORE Association/MassMutual. For FREE and confidential mentoring in creating your succession plan, contact SCORE at www.capecod.score.org or [email protected] or 508-775-4884. Download a free copy of the e-book “Tips from SCORE, Vol. II” www.amazon.com/dp/B08QPR7G35.