Succession Planning – What For?

“Succession planning – what for? I have fun running my company every day and when I am dead, my kids can solve that problem!” [Quote] by unnamed 78-year-old business owner, Newark, NJ.

“No question – such approach is one of many approaches in planning the succession of a successful business, and unfortunately, we see such unpreparedness quite often in estate sales,“ says Achim Neumann, President, A Neumann & Associates, a Merger & Acquisitions and business brokerage firm, headquartered in New Jersey, “however, it can be avoided as it is most certainly not the most meaningful way to ensure the longevity of a business.”

Succession planning for a business owner should incorporate many considerations, including the owner’s transfer of wealth, continued employment for the folks who have helped over many years in the company and ensuring the legacy of a business. Simply leaving a business to its own destiny will most certainly result in significant disruptions due to discontinued management, interruptions to customers with product and service supplies and employees suddenly leaving the business due to uncertainty.  Most certainly not the results most business owners would look forward to!

But how does the successful business owner plan for succession after countless years building up their business?

Essentially, there are three viable “groups” to transfer the business to

• Employees,
• Family members,
• Outside buyers.

The first group is the most problematic one, although many business owners tend to consider this option due to their perceived ‘obligation’ for past and continued loyalty. Sometimes, an ESOP is considered. However, in reality, employees often don’t have the financial resources to put a meaningful deal together for a business owner, more importantly, they lack the qualifications for being a true entrepreneur. Indeed, a great sales or accounting professional does not necessarily make for a great manager or business owner. Nobody is served well to transfer a business to an employee, and thus, potentially jeopardizing the continuation of the business and employment for all other folks in the process – setting aside that such deals are often leaving the business owner with holding a large note (that ultimately is never paid back).

The picture becomes even murkier with family members.

Without question, every business owner would like to see their offspring transition into the business and to continue the family legacy.   But, is a father or mother truly objective in evaluating the managerial qualities of their kids? All too often, such a view is not objective, as a matter of fact, in ninety percent of all the business sales by this firm, there are children but the business owner did not want to transition the business to them.  No question, some children are very qualified and talented, having “looked over the business owner’s shoulder” for many years but statistically speaking, they are the exception.

Essentially, this leaves a business owner with the last group, namely, external third party buyers for the business.  Without doubt, from a financial point of view, such sale is the most beneficial proposition of all.

After a Fair Market Valuation has been established by an accredited, third party valuation firm with a deal structure maximizing a potential transaction, the business sale can be reviewed for its tax implications and the owner will hire an M&A advisor to prepare the business for a sale. A typical planning horizon should be two to three years prior to a planned retirement.

By utilizing a reputable, qualified M&A advisor, the business owner will get access to a large group of potential investors with an established investor pre-qualification process, banking lending resources for investors and a proven deal making process and expertise. It will allow the business owner to continue focusing on the business operations and maximizing profitability while enjoying the rest of their life, and not being distracted by the sale process. Such benefits can not be overstated, as the “DIY” business sell approach often fails – compromising the confidentiality of the sale and seeing dramatically declining business performance (with a lesser transaction amount) in the process.

Once a deal has been closed, the business owner has accomplished a ”conversion” of the business value to cash, to now allow for a partial “cash distribution”, if so desired, to employees or family, in essence benefiting the very same groups that were initially considered recipients of the business in the succession planning.

Such “cash distribution” can take many different forms to family members, such as wills, trusts or outright cash gifts. However, for employees, such distribution can also be tied to certain post-closing performance, such as staying on for a certain period of time, essentially securing continued employment and a smooth transition in the process – a very handy prospective in the deal making process with a buyer.

Ultimately, the outright sale is a win-win situation for the business owner, not only having maximized cash receipts for the business transfer – without the lingering collection fear of large unpaid notes extended to employees or family members – but also now being in a position to determine the fractional allocation of cash between the owner, family members and employees.