The Succession Puzzle
One myth within family business circles is that owners need to ‘let go’
Ironically, many business owners are “too busy” managing every day to start succession planning and protect their business wealth, often their largest retirement asset. That explains why only 7% have a written succession plan. Entrepreneurs are critical to our economy and their succession planning will benefit all of us. One myth prevalent within family business circles is that business owners need to “let go.” You don’t need to let go. You need to get control of the information and the process because they revolve around your goals, your business and your life.
Succession planning will help you protect your wealth, take care of your family and ensure your business survives to take care of your employees and customers. Succession is like a puzzle. It’s about creating lots of pieces of information and putting it all together. The key pieces are information and advisors, successors and financing. The business information includes legal structure, financial statements, business plans, tax and valuations. Personal information includes your will, assets, liabilities, retirement needs, insurance, financial plans and lifestyle choices.
When dealing with your advisors, stipulate that you want written meeting summaries (in plain language!), pictures of recommended structures, time for questions and proactive advice. Key advisors include a business valuator, financial planner, tax accountant and lawyer. The valuation is required at the beginning to estimate the potential value. An important tactic is getting your advisors in one room at the same time. This dramatically accelerates the planning process. Professional valuators are conservative and your business may be worth less than you think so it’s important to know this up front. Conduct your valuation discretely so that you aren’t held to a low number and can increase the value.
Valuations are typically used for estate freezes or tax transactions and are based on earnings, cash flow or asset values. Sale prices to arm’s length parties reflect the purchaser’s estimate of value and should be higher than a valuation. Don’t use the valuation as an asking price to a third party. The financial planner will help you assess your future needs, personal wealth, financial and insurance needs, and develop investment strategies that will protect and grow your wealth. Wealth preservation is obviously critical in our volatile markets.
The tax advisor, often your accountant, will recommend optimal tax structures. In business, short-term tax minimization actually reduces retained earnings, reduces borrowing power and reduces your ability to increase your business value. Tax advisors will give you options of how you can maximize after-tax cash flow and protect wealth. The lawyer will identify risks, recommend legal structures, prepare agreements, update wills and keep important documents organized.
Successors Potential successors include managers, family or strategic buyers. Managers understand the business and know the customers and suppliers but they may lack external perspective. Family buyers share the founder’s values and often grew up in the business, but may face supervisory challenges. Family and managers often don’t have deep pockets and may require vendor financing. Strategic buyers include competitors or consolidators who have deep pockets and can pay higher prices. However, they may want the vendor to stay for a couple of years and tie earn-out payments to future results. The optimal purchaser is one who meets the vendor’s needs for funds and freedom.
A financing expert can help you structure financing to provide cash to the vendors while preserving working capital for the business.
Vendor financing gives the vendor a say in future operations but reduces immediate cash. It’s used for estate freezes and family or management buyouts.
Bank debt has low interest rates but is becoming more difficult to obtain. It’s good for companies with strong balance sheets and cash flow.
Subordinated debt is interesting and can be treated like equity if payments are postponed, thus supporting additional borrowing. Interest rates are more expensive but are cheaper than equity.
Sub-debt can help new owners retain total control and is viable for family or management buyouts.
Venture capitalists inject funds for equity and can contribute to growth and management. The equity funds increase working capital and borrowing capacity. Plans need to be made to finance their “exit.”
High-growth and high-profit companies are a good fit.