Succession: Family Business

Most small- medium family business owners know that someday they will no longer be running their businesses. They may live the life they dream about after they retire; doing something they love that keeps them engaged for the rest of their lives. Or, they may be employed until they are no longer able to run their businesses. I know which route I would rather take. The route that a business owner takes depends on the plan they choose to develop and implement before they are ready to exit.

Let’s look at a few sobering statistics:

  • 63% of private businesses are owned by the baby boomer generation
  • 10,000 boomers turn 65 every day
  • 80-90% of their wealth is tied up in their business
  • According to a recent EPI survey, 76% plan to transition their business over the next 10 years

If all of these owners do decide to sell their businesses it would represent the sale (or closure) of 4,500,000 businesses – what are the chances of a great outcome for the unprepared owner? Another option is to create a succession plan to ensure be outside non-success statistics:

A few more statistics:

  • 12 months after selling, 3 out of 4 owners surveyed “profoundly regretted” the decision
  • 70-80% of private businesses put on the market don’t sell.
  • Only 30% of all family-owned businesses survive into the second generation and only 12% into the third.

Planning for business transitions is a necessary part of good business practices. When an owner doesn’t plan for the transition of the business there is little chance of the business surviving after the owner retires or unexpectedly exits the business. Without a transition plan, passing the business to the next generation successfully is very unlikely.

A Process not an Event

Exit Planning is a process, not an event. Good exit planning takes years but it can dramatically increase the enterprise value and the odds of the business surviving that first generation. Given the complexities and legal and tax requirements of good exit planning, starting early is imperative. One of the by-products of planning for an exit on the owners terms is the consideration given to contingency planning.

It is estimated that 50% of business exits are involuntary. Contrast this statistic with the fact that 67% of companies surveyed say they have no provisions in place if key personnel or shareholders should get ill, die, or otherwise exit the company.

Components of the Exit Plan

A well-designed exit plan should consider both the financial and personal needs and desires of the owner, the needs of the business and its employees, and the role the owners family plays in the business ecosystem. In a BEI study, only 17% of participants indicated that they had a written transition plan.

Owners Financial Plan

A well-designed exit plan will incorporate an assessment of the owners financial, estate planning, and charitable goals. If the owner doesn’t have enough income to accomplish his/her goals after retiring there is bound to be dissatisfaction with the life post exit. A financial planning professional is a necessary part of the exit planning team early in the process. According to a study by the Business Enterprise Institute, only 27% of business owners have calculated the amount they will need from a sale or transfer of the business to meet their financial goals post exit. Add to this, the fact that only 22% of owners have a current valuation of their company.

Owner’s Personal Plan

Imagine for a moment that you have been working 10 hours a day for 40 years building and growing your company. You are challenged each day to grow the business, hire and manage employees, solve problems and make decisions. The business is your life and your legacy. This describes many successful business owners. Now imagine selling that business. What will you do after you take the long overdue cruise, trip around the world, and move to Arizona (or Florida)? Will you be content to take walks around the neighbourhood, play cards with other retired peers, do you have a hobby?

One of the most overlooked parts of selling a business is planning the post-exit lifestyle. For most busy owners this takes some thought and preparation. Will you volunteer, can your hobby expand to fit the retirement lifestyle? If the business is not sold but transitioned to the next generation, will the owner continue to go into the office – and will they be in the way of a real transition if they do?

The Business Plan

The concept of business value is fairly simple. The value of most businesses is tied to a multiple of profit. Increase the profit or the multiple and the value of the business increases. Increase both and the value of the business multiplies dramatically. Value enhancement in the context of exit planning focuses on an assessment of the gap between the practices of best-in-class companies and the current situation. Once these gaps are identified, an exit planner will formulate a plan to close the gaps and increase the multiple. Let’s look at a typical situation for illustration:

Current Situation

EBITA = 20% of sales ($10M) = $2,000,000

Valuation Multiple (Median) = 2.7X

Enterprise Value = $5,400,000

Best-In-Class companies

EBITA = 30% of Sales (10M) = $3,000,000

Valuation Multiple (90th percentile) = 4.5X

Enterprise Value = $13,500,000

Value Gap = $8,100,000

The benefit of enhancing value through planning is obvious. The process of exit planning identifies the drivers of the value multiple and creates a prioritized action plan to address these issues and move the business closer to the best-in-class performance and multiples. Some of the issues addressed can be done in one year or less, but many are multi-year business improvements.

Many owners believe that the best way to close this gap is by increasing sales and reducing expenses. This is not completely correct. Market multiples paid by investors are affected greatly by the business risk; therefore, reducing business-specific risk is the first priority for exit planning. Some of the ways in which an owner can reduce risk are:

  1. Reduce reliance on the owner for day-to-day matters and client management
  2. Reduce Client concentration issues
  3. Make sure Key-man policies and non-compete agreements are in place
  4. Formally define and documented your corporate structure, articles of incorporation and annual meeting minutes
  5. Establish financial systems and scheduled audits, valuations and internal due diligence.
  6. Define necessary digital policies and adopt procedures to support them
  7. Document your backup and disaster recovery process
  8. Clarify ownership, responsibility and accountability for all objectives and communicate these in a way that ensures that everyone in the business understands their role.

Conclusion

Exit planning is not just for owners when they think they are almost ready to exit. Planning is good business for any business owner at any stage. If you have a plan in place you will be ready to take best advantage whenever an opportunity presents itself. You will also be ready if the unexpected happens and you are forced to transition your business because of death, disability, or other business hardship. Most exit planners will provide an initial assessment at no charge to scope out the terms of an engagement and get a rough idea of the current state of readiness.