Your first option for transitioning your business may not be your best
November 12, 2020
By Martha Sullivan, CPA, CVA/ABV, CM&AA, CEPA
Partner, Succession Planning Practice Leader
Martha leads HK’s succession and exit planning services division and is a regular contributor to Wisconsin’s InBusiness digital magazine.
2020 has renewed business owners’ thinking about company ownership. For some owners, 2020 is merely another bump in the road that they will roll over while holding the steering wheel tightly. For others, it’s been a perverse rush, literally and figuratively, as business has grown with the shifts in consumer and commercial demand. Then there are those that have had enough. There is little gas left in the tank and the next station is miles down the road. It’s time to take their chips and their risk off the table and go do something else for a change.
Regardless of where your energy lies, chances are if you’re a business owner, getting out has crossed your mind this year. It’s a good time to pick up on that thread and talk about it.
When I start the conversation about exit options with many business owners, the immediate response is “I know what I’m going to do.” The fact of the matter, supported by the numerous Exit Planning Institute surveys on the State of Owner Readiness, suggest the opposite:
- 80% of business owners have no written company transition plan, and
- 60% of business owners are unfamiliar with their transition options.
To me, this indicates that the “chosen” path is more likely a glint in the eye than a fully vetted exit path.
When it comes time to think about transitioning the ownership of your company, it can be overwhelming. There are many elements to consider. Certainly, the cash and return on your blood, sweat, and tears over the years is an important consideration. For many owners, what happens to the business after you leave — your customers, employees, and suppliers — is equally, if not more, important.
Your available options for exit are dependent upon your unique situation and fall into two primary categories, each with their own advantages and disadvantages:
Inside transitions are those ownership transfers that occur between individuals already somehow affiliated to the current owner. Potential options include next-generation family members, current co-owners, up-and-coming managers, or the employees if your company is suitable for an Employee Stock Ownership Plan.
- Advantages: You know who you, as the seller, are dealing with. Your buyer presumably has a stronger sense of what they are getting into. This familiarity offers comfort on both sides. If there are currently multiple owners, you may even have documents — in the form of a shareholder agreement — to guide the transition, including pricing. Inside transitions have a stronger opportunity to preserve the legacy of the company, which many find both appealing and compelling.
- Disadvantages: Inside transitions, from a financial perspective, tend to provide a lower payout. This may be by design or simply a reality. For example, one company I know deliberately sets its annual share price at a number that is significantly lower than market value because they don’t want an ownership transition to cripple the company’s cash position. I’ve seen other owners discount the price for their business because the incoming employee/family member owner simply doesn’t have the money to pay what the company is worth. The emotional payout of transitioning it to someone they know and care about outweighs the financial interests, which may be OK as long as you have a good handle on what you, as a seller, have as a financial base and plan to guide you going forward. Another disadvantage is actually an inside transition’s primary advantage — familiarity. Inside knowledge combined with emotional baggage is a potent swill that can poison businesses and those once-valued relationships. It’s also easy to make assumptions about capabilities and intentions that may not bear out, setting the future success of the company at risk. This is particularly true in a family business transition situation.
Outside transitions include two primary options — sell to a strategic buyer, such as an industry player, or sell to a financial investor that is willing to make the investment but is not interested in running the business, such as a private equity fund. Two other outside options also exist that are usually not in contention for top choice by many business owners, those being going public through an initial public offering (IPO) or simply turning off the lights, closing the doors, and selling all the assets in an orderly manner.
- Advantages: Bringing in a new owner offers a company the opportunity for a new set of eyes that may take the company to its next level, and, at the same time, offer the seller a higher purchase price than an inside transition path. While there may be a consulting agreement for some period, the outside strategic buyer option usually provides you with a cleaner break from your day-to-day involvement in the company.
- Disadvantages: The most significant disadvantages circle issues of control of your legacy and, if you are still involved in ownership, control over the business itself. Shifting a mindset is challenging for everyone on the planet. If you have been in the position of authority over the direction of your company or certain decisions, letting go of this is baked into the deal. The key is readying yourself for it so when they redecorate, roll out a new name or logo, or change more impactful aspects of “your” company, you can still maintain a steady state.
When considering the various options, many owners I know have a preconceived notion about which path is right for them without understanding the elements that set the stage for a successful outcome. The reality is that your assumed path could be taken off the table completely out of your control. Your kid decides they want nothing to do with it. Your business partner turns into a jerk. Your company isn’t attractive to your favorite strategic prospect.
In 2020, we all share a common desire: we want answers, we want to know what our options are, and we want to prepare for what comes next.
If you are an owner of a business today, learn about each of these different options, even if you still have gas in the tank with backup reserves. The more you know about them, the more likely it is that you will make better decisions along the way and keep as many of these options open to you. If you feel the tank may be light, all the more reason to start exploring your options today.
Let me know your thoughts! I’m here to help.