Transitioning Out of the Business You Built
Canada’s population is aging and included in this demographic are a significant portion of Canadian entrepreneurs. According to a 2017 survey by the Business Development Bank of Canada (BDC), 41% of Canadian entrepreneurs expect to exit their business without acquiring another in the next five years. As an entrepreneur it is likely that you have prioritized building your company and given little thought to the day you inevitability leave it.
Failing to plan for your transition can lead to lost company value and an exhaustive succession process. Succession planning is often a complex and emotional process for the business owner, their family and employees. It is important to start as early as possible to garner an objective approach to your succession and alleviate some of the emotional difficulties of exiting a business.
The first step to business succession is finding a strategy that best suits your needs. This step doubles as one of the primary advantages of succession planning in that is provides entrepreneurs with an honest assessment of their options. Many owners are under the assumption that when the time comes, they will be able to easily sell their business. But this does not hold true, getting your business to be sale ready involves extensive value optimization to attract buyers. On average, you should start planning your succession a minimum of 18-24 months before your desired exit; although, implementation can take 5-10 years depending on your strategy. Building a comprehensive transition plan is critical as each family solution will have unique considerations that will impact the option pursued.
Choosing an exit strategy
- Family Succession
When considering a family transfer it is important to keep the following points in mind.
The most obvious choice is not always the best.
Many family business owners make decisions on their successor based on seniority. It is important that the next-generation owner has gained respect from both the family and employees, fulfills certain leadership objectives, has exhibited interest in taking over the family business and has industry expertise. Remember to be open in your search beyond your ‘next-in-line’ kin.
Maintain an objective analysis.
This goes hand in hand with our first point but can be severely underplayed in succession planning. The more inclusive and considerate the process of choosing your successor is, the more likely your employees will embrace the transition. Identify top executives and managers who also fit the bill and rank all possible successors based on key indicators that are fair and measurable. For example, job experience, advancement within or outside the company, level of education, previous leadership experience, interpersonal skills, aversion to risk and so on.
While keeping the business in the family will continue the company legacy there is high potential for conflict within the company and family dynamic. As a business owner, it is likely that your business represents at least half of the value of your estate and you may be relying on the value of your business to serve as a source of liquidity to fund all of part of your retirement income. If you plan to see your business continue, it can be incredibly satisfying to pass the reins over to a trusting family member and relinquish some control over business decisions. However, there are a few important concerns to keep in mind to ensure you are able to maximize your personal financial security upon transfer. If you intend to extract a considerable income or amount of capital for your retirement plan, consider if this extraction will weaken your business, the ability of your successor to re-invest money or capital back into the business, the company’s inevitable peaks and valleys throughout the business cycle and tax implications. Timing will be important – if your need for retirement income aligns with a profit valley, your business may fail to survive the next period.
According to the same BDC survey, 52% of sellers expect to sell or transfer their business outside the family. This is not surprising considering a family succession plan is limiting in terms of payout relative to a third-party sale. Additionally, a non-family successor brings diversity of experience, strategic alliances, partnerships and opportunities to drive growth that a family member may not.
- Management buyout (MBO)
An MBO is the partial or full acquisition of a company by its management team. This process ensures a smooth continuation of business throughout the shift in ownership. You will feel confident and safe in your exit decision as the company will be in the hands of employees who have exhibited longevity, loyalty and have in-depth knowledge of the business. Additionally, an MBO allows the company to maintain strong relationships with their employees, suppliers and customers free from disruption.
The key advantages of a MBO are similar to family succession in that it protects the legacy and maintains independence of the company. However, there are some important setbacks to think about. The management team may have limited access to capital and this can negatively impact the valuation of the company, final selling price and terms of the sale. In this case, you may be at risk of a vendor financing agreement where you will effectively loan a portion of the purchase price to the buyers. This may result in a smaller than expected financial gain towards your retirement plan.
- Private Equity or a Non-Strategic Buyer
As Canada’s baby boom generation nears retirement, a new wave of business transitions is fast approaching. This means that the market for buyers will be extremely competitive and business owners will have to optimize their company value in choosing to sell. If you are an entrepreneur, your business is likely your biggest asset, so you will want to ensure the highest possible return on your sale. Below are a couple ways you can improve the value of the company and become sale ready.
- Continue to invest in your capital assets up to the point of sale. This will differentiate you from competitors who have neglected to keep their infrastructure and equipment up to date. Investing in your company’s online presence will boost your value and develop buyer interest in your company.
- Keep detailed and reliable financial reports. A responsible buyer will look for audited reports that show stable profits and growth for at least three years.
- Tap into a pool of professional advisors. Hiring an advisor who specializes in business transitions will streamline the process and may be able to identify prospective buyers outside your local market.
A non-strategic buyer includes private equity firms, venture capitalists, hedge funds and high net worth individuals who are interested in realizing a return on their investment. If you are able to provide justifiable grounds for future growth opportunities and sustainable competitive advantages, you many attract these financial buyers. The main advantages of securing a non-strategic buyer is job security for management and employees and a large cash offer. The purchase price is typically lower than with a strategic buyer as a financial buyer is solely focused on monetary gain and not in company synergies that could justify a premium.
- Strategic Buyer
A strategic buyer involves a company that is looking to grow within the market you are operating and diversify their revenue sources. It may also be a related company, often a competitor or supplier of your business who has recognized certain synergistic values between your business and theirs and is looking to integrate in hopes of achieving long-term shareholder value. You may want to consider this option if you are looking to reduce but not eliminate your involvement in the company through a phased exit. This strategy ensures the new business owner is trained under your eye. In order to minimize turbulence during a takeover, it is important that the new owner has assumed most of the day-to-day operational responsibilities, and proven their resilience with employees, suppliers and stakeholders. A takeover can be seen as a point of weakness by competitors who may try to exploit your position so having a confident and well-groomed managerial leader is essential.
This option will yield the highest purchase price. Additionally, your business will reap the benefits of stronger supplier relations, cross selling to customers, access to capital and so on. However, a strategic buyer will retain all or most control over the company and may employ company-wide lay-offs and cost cutting strategies.
The cost to business of last-minute execution of a succession plan is not trivial. Choosing your exit strategy is only half the battle, but it is the first step towards ensuring you realize the highest possible value for your business, while allowing for a smooth transition of new ownership. In developing a sound transition plan ask yourself the following questions and seek guidance from a financial advisor:
- What is the vision of the business under my ownership vs. new ownership?
- What am I willing to negotiate and what are my non-negotiations?
- Is the current management team entrepreneurial? Should I consider external buyers?
- How much due diligence is required with this option?
- How do I plan to retire? How much will I need?