Navigating Uncertainty Around Business Succession and Transition
Planning, Timing and Keeping Emotions in Check Are Keys to Success
Succession and transitions in family-owned businesses can be riskier than a transaction at arm’s length between sellers and outside buyers. This is especially true if the transitions are handicapped by three factors – lack of planning, poor communication, and emotions. Often, this can be the case whether the intended transition is to ownership by a child or other relative of the retiring owner or to a key employee who has been with the company for many years.
Add to that the complicating factor of today’s strong merger and acquisition market and you may have unforeseen marketplace pressures compounding the stress. With outside buyers offering higher purchase prices in today’s M&A environment, business owners who previously had planned to sell their companies to children or other family members are reconsidering. Many of these stress factors can be avoided if sellers observe some basic rules of the road.
In a typical scenario, the owner of a company is looking toward retirement and may have already reached retirement age. The owner’s son or daughter has worked in the company for several years in an executive role. But important conversations have not occurred and key decisions that take time to bring to fruition have not been made, such as:
- What would happen to the business if the owner suddenly died or was incapacitated?
- Has the owner spoken with stakeholders about any plans?
- If the child is expected to buy the business, have they been educated, trained, and positioned to be successful?
- Have key advisors – the company’s lawyer, accountant, and banker – been involved in any succession planning?
Don’t procrastinate on doing this kind of planning. If you want your business to continue being a family business, you have to make it happen.
Often, family business succession planning is delayed because it is wrapped up in family dynamics. The owner may feel that the business is his baby and is reluctant to share the secret sauce with children or other family members who may tinker with the recipe. Fear of becoming irrelevant is real. Involving outside advisors such as a lawyer or an accountant in family discussions about succession can help cut through the family dynamics and keep the planning on track.
One of the most important considerations to deal with up front is timing – when and how will the transition take place? Timing of the transition is a fundamental part of communication. Until the timing is determined, finding answers to many of the other questions can be put on hold.
Depending on the nature of the company’s operations, will you need to stay on for an earn-out period? Your expertise and relationships with customers, vendors and employees may be needed to help transition the business.
The earn-out period is also a payout period, which can be helpful in a family business your child does not have the money up front to finance the full deal. If you are willing to offer financing or the buyer needs to finance on a note, these choices will impact timing.
Once the timing is determined, it’s time figure out the value of the business. The best time to have a valuation performed is when you’re starting to prepare for the sale. You can get a true inventory of the business including the current condition of equipment, the status of vendor and customer relationships, the status of your workforce and employee relations, the condition of the building, and the value of component assets. It is also a time to evaluate the intended buyer’s current role in the business and what it will take to prepare them for the ownership role. How will stakeholder relationships – employees, customers, advisors – be transitioned to the new owner?
If the intention is to sell or transition the company to a child or other relative, the ideal time to start succession planning is the day they join the business. But that rarely happens. In most cases, at least 18 to 24 months of planning are required to get a sense of the company’s value, work out financing and payout details, and put a transition plan in place. In some situations, three to five years may be ideal.
Today’s M&A market has sped up the decision making and preparation phase for many owners who may be receiving unsolicited offers higher than they would expect. Considering many of them are concerned about the impact of impending changes in the federal tax code, it’s hard to turn down these offers.
Even in the most stable families, parent-child dynamics can complicate decisions about succession in a family business. The natural desire parents have to see their children succeed, all while providing security and protection, can impair the professional judgment needed to make important business decisions. In short, it’s the conundrum between making decisions based on logic and reason versus decisions influenced by inherent bias. However, it is arguably the most important part of a transition. The more decisions that you as a business owner can make with your mind as opposed to your heart will better enable a successful transition, even if it involves the people in your life that you love the most.
If you have held back on sharing information about how to run the company with your child, now is the time to discuss these details. Additionally, don’t expect your son or daughter to run the company exactly the way you have. You wouldn’t expect that of an outside buyer, so there’s no sense in complicating the transition to a family member with such requirements.
As an owner and an individual that has known your child since birth, you should be as qualified as anyone to evaluate your child’s readiness to assume ownership of your business. Having the insight into your child’s professional abilities and shortcomings – or those of a key executive who has worked for the company for many years – can help lay a foundation for structuring the transition period in a way that allays certain fears.
Sometimes it’s valuable to apply a “traffic light” standard to figure out if your child is ready to assume ownership of your business.
- Green light – Your son or daughter has worked at the company for several years, is already acting as a shadow CEO, or perhaps already is the CEO. You are confident in their ability to assume the reins.
- Yellow light – Your child has s the competency to run the business but may need some experience, resources, or help. This help can come in a variety of forms: key executives/business coaching, upgrades in technology, investments in the financial transparency of the business, etc. It’s a good time to make investments in your business designed to facilitate the transition of your child into an ownership role and navigate your business on a path towards success.
- Red light – You realize your children don’t have the desire or the skills to own and run the business, and there are no other likely internal successors. It’s time to find an outside buyer.
In other words, be realistic and understand who the buyer is, especially if it’s a family member or a key executive who has been with you for many years. If they have ideas about how to run the business differently than you, this does not mean they are disloyal. It means they care about the business and want it to grow in the future.
Additionally, keep your expectations in check. Things won’t be perfect after the transition, even if you are still on board during an earnout period. There is nearly always a loss curve during the transition when the company’s results go down, but then rebound over time. The key is to manage expectations and manage the situation.
If you would like to have a conversation about putting a succession or transition plan in place for your business, contact your Adams Brown advisor.