A New Approach to Business Succession Planning

Spring 2017Articles For Your Benefit

We are regularly involved in discussions with business owners concerning succession planning, with both existing and prospective clients, and participate in a variety of seminars covering this subject matter. While the discussion is no doubt similar amongst this very general group of business owners, the seminars often fail to capture their attention in a manner likely to spring them into action. In order to protect the guilty, here is a paraphrased course description from such a recent seminar: A way for business owners and their professionals to consider and evaluate different deal structures, to minimize taxes and use deal proceeds to satisfy spending, wealth transfer and philanthropic goals. Therein lies the problem. Deal structures, taxation, wealth transfer – all financial and economic terms. While it may be a shock to many who put together M&A transactions, or invest the proceeds, the sale of a closely held business is far more than a mere financial transaction. While the foregoing disciplines are an essential element of any resulting business sale, focusing on those matters is not necessarily the best way to begin the succession process in our experience.

For most closely held business owners, their business constitutes far more than a collection of assets. Those who own or advise closely held businesses and their owners know that the business represents the owner’s major personal – as well as professional – investment in time, effort, focus and commitment for the last 25 to 50 years. The transition from sole business owner to former business owner involves a myriad of emotional and psychological issues that must be addressed before a business owner can think about the financial aspects of the sale. Most retirees encounter some of the issues relating to isolation, loss of work relationships and loss of the status and identity associated with a high-level position. However, these issues are particularly acute for business owners and should not be ignored when discussing succession planning.

In our experience, the most productive discussions often start with the simple question: What do you want to do with the rest of your life? The reality is that most business owners are so involved with the day-to-day operation of their business that they have not seriously considered the answer to that question. To many, the subject raises uncomfortable questions about mortality and self-worth outside of the business. As uncomfortable as the question is, it is a necessary first step to any meaningful dialogue. The reality is that most owners are less concerned about squeezing the last dollar out of a third party buyer than finding a comfortable path into retirement while leaving the business in capable hands. The tendency of many business succession advisors is to put the proverbial cart before the horse and it is one of the reasons that many business owners delay and procrastinate.

We frequently counsel reluctant owners and prognosticators that there are generally three ways to exit a business: (1) a sale to a third party; (2) a sale to existing employees; and (3) horizontally. Every time they put off a succession planning decision or find another everyday problem to deal with in lieu of the transition plan, they make a decision to move closer to the third option. Obviously, this implies that the individual dies without any meaningful business succession plan, thus representing the worst option for all concerned, including both the business itself and the business owner’s family.

Many owners would opt for a transition plan that would allow them to remain in control while gradually reducing their role at a time and place of their own choosing. A sale to employees either directly or through an employee stock ownership plan (ESOP) is often a palatable answer. The key difference between a sale to employees and a sale to a third party is control. Depending upon the type of third party buyer, the owner can generally expect to receive a two to five year employment contract. Make no mistake, however. This change from owner to mere employee is the first step towards the complete loss of control, a process that generally occurs on the buyer’s timetable. While some owners view this as an inevitable part of the transition process, others view being in charge of the business as an essential part of their self-worth and reason for continued involvement. To these business owners, losing control of their transition timetable is simply unacceptable. By contrast, most sales to employees can easily be structured to allow the former owner to remain in operational control for as long he or she is willing and able – as this is typically mutually beneficial to both the buyer and seller.

In addition, a sale to employees will preserve the independent legacy of the business and can significantly retain more jobs for long-term, loyal employees. To many owners, these employees are like family and keeping their jobs intact is an essential part of any transition plan. Many who subscribe to this line of thinking (i.e., those who sell to third party buyers) are able to negotiate a one or two year protection for their employees – at some cost to themselves in the form of a reduced purchase price. However, in our experience, many of the employees who enjoy these protections are terminated the day after they expire as the new ownership looks to make its mark on the business.

Although a sale to employees offers certain critical advantages, it is not without challenges. The two most significant challenges involve financing and developing the next generation of leadership. In many cases, it makes sense for the owners to finance the sale, requiring them to remain with the business for some period of time. In a typical owner-financed transaction, that period is approximately five years, as this duration is generally sufficient to ensure repayment of any debt created in connection with the sale. The five year period is also the amount of time generally required to develop the right kind of talent to take the reigns from current leadership. It is more likely than not that the owners hold those reigns tightly and the sale is the impetus to begin serious succession planning with respect to others taking operational control of the company.

It is our hope that business owners reading this article take away three critical points. First, begin the discussion of the business by examining your own needs and desires as to when and how you wish to exit from your business. Second, consider a sale to your employees as one of those options. It is not ideal in every situation, but still clearly worthy of consideration in many cases. Third, and most importantly, begin your planning early. Every day that you wait brings you one day closer to the doomsday scenario of your heirs being required to sell your business at a fire sale price.