Sometimes referred to as the “necessary evil,” business transition planning or deciding on a succession plan can be an emotional time. Selling a company is not easy, particularly if the business has been part of your family for many years.
If you are looking to transition or sell your business, you may be unsure how to get started. While developing your business succession plan, breaking the process into steps will make it more manageable.
Business succession planning is the process of creating and implementing a strategic plan for a business designed to combine the emotional and financial needs of the various members involved, typically the business owner, family members and key employees with the needs of the business to maintain it as a viable ongoing business. The emotional and financial needs are often the most difficult.
One of the greatest deterrents to a business owner moving forward with developing a succession plan is the emotional impact that comes with planning.
It can be difficult for an owner to talk about their role and the future of the company without picturing themselves in it. They are often so emotionally tied to the businesses that even the discussion of it can be painful. However, often what the owner doesn’t realize is that they are in control of the transition and the future success of the company and that control comes from the planning. It provides the owner an opportunity to have conversations now and then over a determined period of time develop a method for the transferring of control. One of the greatest legacies an owner can leave behind is the successful transfer of the business to the next leader(s).
In the situation of a family business, the involved family members need to be a part of the discussion. Is there a logical leader and has that person been asked if they want to lead? If asked, the answer might surprise you. They may not want the responsibility, or they may prefer to only lead an area or division of the business. And then there is always the financial discussion and the ‘how to be fair’ with all involved. These are tough conversations, but what is far worse is the aftermath of doing nothing, which can often cause unrest and the feeling of uncertainty with your employees and customers, not to mention family members.
The actual transfer of control of the business, whether it takes place during a short time period or over several years commands the business owner to ‘let go.’ However, letting go slowly, giving the soon to transition leader permission to make decisions can be rewarding. Praising them when they succeed and then helping them when they fail, will provide them with the enhanced skill set to handle situations after the business owner exits the business. It is a lot like teaching your child to ride a bike. You put on training wheels to help them ride the bike, but they still have the support of the wheels. Then as time goes on you take off the wheels, but you still hold the back of the seat for the first few times they ride, then as their confidence builds, you let go. The joy that comes from seeing them soar in the business, or on the bike, is worth all the work put into the transition.
Part of the planning process will be to ensure the viability of the business by minimizing financial demands. Many business owners delay retiring or giving up control of the business because they don’t think they can afford to retire, or perhaps they think their health is good and it will always be, or even more, they think the business won’t survive without them. Depending on the business and the overall transition plan, there are numerous ways to take care of the financial needs of the owner and keep the business stay viable. Further, estate taxes are not a myth – they exist. Having a plan that addresses how they are to be handled is important to the financial health of the family and the business.
No business owner or leader should do this alone. Surround yourself with your ‘team,’ which is the group of advisors that often include your attorney, accountant, banker, insurance advisor, etc. By having all of the ‘team’ members on the same page with your plan, the timeline and the process, you are safeguarding the transition and helping ensure it against misunderstandings that can lead to failure. Also, take time to introduce your soon to be transitioned leader(s) to the team and make them a part of the discussion as well. The more transparent the process, often the better the outcome.
There are many more details in a business succession plan than those outlined here, but this is meant to get you thinking and hopefully moving in the right direction. A great next step is to assemble your ‘team’ and start discussions. The training wheels get put on the bike by you and your ‘team’ will help you with tools. Remember, you are not defined by the business instead, you define it and its future.
Here are six steps to help you with the business succession decision process.
If you are the owner of a privately-owned, family-run business, there are likely a range of financial and family issues to consider. Asking yourself some targeted questions can help you evaluate your path forward:
These questions will prepare you for a potential sale and help you select, educate and empower your succession team to preserve the long-term health and success of the company.
Making the decision to sell an asset you’ve owned from the ground up can be difficult. Proactive checkups with your financial advisor provide the opportunity to ask the right questions upfront and prevent seller’s remorse in the long run.
A significant factor in your decision will be the financial aspect. Here are a few questions to ask to help you evaluate the soundness of the business:
Making critical decisions about whether to sell extraneous assets or terminate unnecessary employees will help you see your business from the eyes of a buyer.
In addition to looking at your company’s current financial state, it’s critical to evaluate the future earning potential of your business. Consult an expert to provide a business valuation with industry-specific EBITDA (Earnings before interest, tax, depreciation and amortization). It will be necessary for you to prepare a budget for at least the next year and possibly multiple years in the future to properly value your business. Tip: Family member salaries and certain personal expenses often need to be adjusted to accurately reflect the true value of the business.
You’ve made the preliminary decision to sell your business and assessed the current and future financial position – now what? The next step is to decide whether to look for a financial buyer or a strategic buyer for the transaction.
Financial buyers such as Private Equity Groups (PEGs) are likely interested in buying your business primarily for a return on their investment. On the other hand, a strategic buyer may be a company in your industry looking to expand their reach. Take the time to research potential buyers before taking the next step. Consult a financial advisor or broker to make sure you’ve done your homework.
Before you sell your business, it’s imperative to have a plan in place for the proceeds. Asking these questions will get you started:
Prior to the transaction, set up an investment account with your investment advisor, who can examine all the aspects of your investment portfolio. Transitioning from an illiquid, income-producing asset to a liquid asset takes significant planning, and an advisor can help you analyze and anticipate your changing lifestyle. TIP: Don’t forget your taxes. Your tax situation may be different in the future, so be sure you account for taxes when planning.
Seek guidance to help you evaluate your immediate needs and plan for the future, including setting aside funds for future tax payments. Investment advisors, wealth management consultants and family offices can serve as the buffer or “bad guy” to long lost relatives or friends with an investment idea who may come out of the woodwork asking for money. In addition, they provide an objective assessment on what is best for you.
Now that you’ve made the decision to sell your business and you have a financial plan in place, the final stage is to draft your estate plan. Estate planning is more than just leaving your assets to your loved ones, and it’s not a one and done project. Consult an expert who can regularly review and update your plan as your portfolio grows or tax issues change.
If you decide you want a sale that will result in the most up-front cash and the greatest return on the sale, it will likely be to an external buyer. But what if your priority is to remain a staple in your local community? Do you have other family members that you would want to take over the business? If so, do you plan to gift the business or purchase the business at fair market value?
If you are looking to sell to an external buyer, you have two options: Strategic Buyer or Private Equity Investment. External buyers typically have platforms in place; therefore, they will have potential add-backs to generate a higher Earnings Before Interest Tax Depreciation and Amortization (“EBITDA”), and ultimately a higher sales price for you the seller. The sale to a private equity group also could allow for the owner to maintain a minority ownership and active responsibilities within the business, if they so desire. However, it is important to know that the minority interest being retained will likely be diluted based on the private equity group’s preferred stock and related dividends. Also, in order to comply with public accounting principles, it is very important to quantify the consideration transferred. It could be simply cash, but oftentimes, there are additional layers to consider.
In an ESOP, Companies set up a trust fund for employees and contribute cash to purchase the company. If the plan borrows money, the company makes contributions to the plan to enable it to repay the loan. Contributions to the plan are tax-deductible. Employees pay no tax on the contributions until they receive the stock when they leave or retire. They then either sell it on the market or back to the company. Under certain specific criteria, the seller of the Company to an ESOP can defer capital gains taxation on their gains by reinvesting in securities of other companies.
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As is the case in all transactions, for family owned businesses, it is important to be honest with the seller. If there are no specific family members prepared to take over the business, that should be directly communicated to the seller. So many times, we see the second or third generation inherit a business, but they are not prepared to manage the business effectively. However, once the seller has identified family members who are prepared to take over the business, it is equally important to begin succession planning and transferring ownership interest of the business to the appropriate family member(s). This process allows for the seller to begin transferring responsibilities to the appropriate family members and reducing the potential estate tax burden placed on the family members. Gifting a minority ownership offers the seller a tax strategy for estate planning as the receiver of the gift can apply discounts for lack of control and liquidity, which helps reduce the seller’s lifetime exemption from federal gift taxes.
You have built something special and you should be proud of that. Beginning your succession plan will help you understand the value of your business and what the best option may be for you. LBMC would love to chat with you and assist you in all the many steps that go with selling a business.
Most business owners don’t immediately think about the valuation implications that a change of control transaction might have, but valuation should not be forgotten. In order to comply with public accounting principles, it is very important to quantify the amount paid or what is also called the “consideration transferred”. The consideration transferred may be very simple and consist of only cash, but oftentimes, there are additional layers of consideration in the form of roll-over equity or contingent consideration.
In today’s environment, we see many transactions that consist not only of a cash payment for the organization, but include rollover equity, meaning that you the seller retain a portion of the equity in the acquired company, or that you may be issued equity in the buyers’ organization. This is intended to incentivize you to continue to contribute to the future success of the company after it’s acquired.
We also have some buyers using incentive payments that are paid out if the organization meets certain performance targets. A lot of these are tied to revenue, customer retention, or cashflow, usually on EBITDA. For example, if the target company currently has $100 million in annual EBITDA, the buyer may commit to make an additional payment if the company achieves $120 million in EBITDA over the next year. This type of mechanism results in a contingent payment, and there is very specific guidance to determine the fair value of that contingent payment at the time of acquisition. The higher the fair value of the contingent payment, the higher the overall consideration transferred.
Once the consideration transferred is determined, one must then allocate that payment to various identifiable assets and liabilities. Essentially a walk down the balance sheet of an organization is needed to allocate the consideration. Certain balance sheet items are relatively simple, like cash and receivables. Fixed assets – equipment, for example – would also be restated at their fair values versus their depreciated net book value.
In addition, accounting principles also require that certain intangible assets are recognized. Most people are familiar with intellectual properties such as trade names, copyrights, and patented technologies. In a business valuation context, we also encounter other intangible assets, for example, software, internal knowhow, customer relationships, trained and assembled workforce, and many others. There are many potential intangible assets that should be considered and recorded at fair value. Once the consideration is allocated to identifiable assets and liabilities, any residual amounts are recorded as goodwill.
Private companies and non-profit organizations can elect an accounting alternative that allows certain intangible assets to be subsumed into goodwill. This eliminates valuation requirements for certain intangible assets and hence reduces the complexities of a purchase price allocation.
If you are thinking about selling your business, ask some preliminary questions before you get started. Selling a business is a momentous decision, especially if you built the company from the ground up or it’s been in the family for generations. Before you make your decision, engage an expert to help you manage the process. Taking the time now to ask the right questions will pay off in the long run.
