1. The transition of business ownership is a long and involved process
Proper planning for the orderly transition of a private company is usually deferred for a number of reasons. Many owners do not have a firm date in mind for their exit from the business' affairs and feel uncomfortable discussing these plans with their close friends and family members. However, underlying this inertia is the (incorrect) assumption that it requires only a matter of months for an ownership transition to be arranged and implemented. In reality the preparation, marketing, negotiation, financing and post-sale responsibilities will typically last between 2 and 5 years, and sometimes longer if unforeseen problems arise.
A better understanding of the process will ensure that owners are able to take advantage of the full range of alternatives available to them, thereby enhancing the value and future prospects of their organization.
2. It's important to begin with reasonable expectations
When asked to objectively assess their business owners will often overstate its positive aspects and understate its negative aspects. This could be due to an inherently optimistic nature or perhaps, after years of continued success, owners tend to overlook or diminish the usual risks and challenges.
Similarly, parties who are unfamiliar with the operations and challenges of the business will tend to provide more conservative, or even pessimistic, viewpoints of its affairs to account for their own uncertainty.
These distorted points of view, when not properly addressed, can result in a tremendous gap in performance expectations and make it virtually impossible to effect a smooth ownership transition. In this regard it is often essential to seek the counsel of an objective, experienced and informed advisor prior to initiating any succession process.
3. Maintaining trust and integrity are paramount
Successfully operating a business often requires an "adversarial" mindset. Owners must manage the competing demands of customers, suppliers, and employees while protecting their own interests. This uncompromising mindset will sometimes translate into an instinct to "get the better end of the deal" which can jeopardize the sense of trust in a negotiating dynamic.
If potential successors get the feeling that anything other than a "fair" deal is being sought by the owner their suspicions will grow and progress will grind to a halt as each new development or interaction is examined for possible ill intent. Being upfront and honest about your expectations from the process will save both time and money, and will greatly improve your chances of finalizing a deal.
4. Numerous stakeholders play a role in the process
The transition of a business is a complex affair and it is often necessary to consider the viewpoints of other stakeholders in the process. Among the stakeholder groups which commonly play a role are family members, key business employees, and professional advisors.
Family members can be among the best counselors through this process as they are in a unique position to understand the owner's priorities and whether the business owner is emotionally prepared for this major lifestyle change. The succession process will impact the family's lifestyle as well, and their concerns should be understood and considered by the owner throughout the process.
Businesses are of little value without the skills and experience of the key employees who successfully manage its affairs. Any successor will be highly reliant upon a continuation of the existing talent base, and greater assurances in this respect will result in a greater value being realized for the business.
Occasionally, transition processes arise where it becomes necessary to negotiate financial terms with existing management or family members. Deals of this nature have inherent conflicts and present their own unique challenges. Objectivity and fair dealing (while remaining sensitive to personal dynamics) are key to transition processes with these dynamics.
Finally, transaction advisors can serve as objective and experienced counsel on matters of price, deal structure, tax planning, and other important matters. In this regard, it is important to align the advisor's interests (though compensation structures, etc.) with those of the business owner in order to create a productive and positive working relationship.
5. The quality of potential successors varies widely
Many people are interested in buying a business and departing owners will often be inundated with opportunists, dreamers, and bottom feeders. In reality, very few individuals or groups have the financing, professional skill set, industry knowledge, and personal character that is necessary to make a fair and successful offer. Quickly identifying qualified buyers and determining the most promising candidates will result in a tremendous savings of both time and money.
6. Creative deal structuring can overcome many differences
Regardless of the strength of your relationship with the potential successor, there will inevitably come a point in the process where a fundamental difference of opinion arises. Some of the areas where these differences commonly arise are:
- future financial performance or spending requirements;
- the retention of key employees; and
- the collectability of certain accounts.
Rather than allowing these issues to overwhelm and defeat the possibility of an agreement, you should remain open to the possibility of resolving these issues through creative negotiating (e.g. clauses within a shareholder agreement, contingent payment structures, representations and warranties on major issues, non-competition agreements, etc.). However, it is also important to stress that modified deal structuring should not be relied upon as a substitute for a thorough due diligence process.
7. Providing access to information is essential
In many small to mid-sized businesses the owner also manages the company's daily operations. This often means that the financial and operational details of the business are closely held by the owner and treated as a matter of great privacy. However, when contemplating an ownership transition it usually becomes necessary to divulge a number of sensitive details about the business in order to entice and inform the prospective successors.
Discussing such private matters with potential successors (regardless of whether they are total strangers or close family members) can be extremely stressing for owners. Accordingly, it is important to attain a state of trust with your counterparty prior to exchanging any sensitive information.
It should be noted that any proposals tendered prior to the review of key pieces of information should be viewed with skepticism as they are likely to be revised after access to the business data is granted, and perhaps materially so.
8. Emotions are often stronger than reason
Owners are often unaware of just how deeply their personal sense of purpose and identity is connected to their role with the business. It is not unusual for an individual to begin a transition with the best of intentions, only to realize a growing sense of discomfort as the process unfolds. Individuals with poor control over their emotions will often act against their best interests and, as a result, their behavior can sabotage an otherwise successful transition process.
It is therefore important for vendors to begin with a strong understanding of their emotional connection to the business, and an ability to view that relationship objectively when evaluating their alternatives. Having keenly developed emotional intelligence skills will also help owners to build and maintain productive relationships with their potential successors.
9. Thorough preparation pays off
Prior to the actual transition there are a number of opportunities which, if properly taken advantage of, can result in tremendous financial gains and greatly aid the succession process. Among other things, these opportunities could include:
- introducing an appropriate corporate structure. By utilizing investment holding companies and adding new shareholders (e.g. spouse, children) a business owner can avoid or defer a significant portion of the taxes on transfer. Current legislation requires that many of these planning initiatives be in place for at least 2 years prior to the actual transition;
- securing the continuing contributions of key employees over the long-term and assuring that those employees are properly incentivized;
- identifying and, where possible, minimizing risks associated with the business' supply chain and customer relationships; and
- assuring that key pieces of the company's intellectual property (i.e. patents, trademarks, domain names, etc.) are properly protected.
By identifying and resolving these types of issues in advance of the transition an owner will improve the attractiveness and future prospects of their business, while also increasing the breadth of available options.
Finally, perhaps the largest risk associated with the transition process is the introduction of new ownership and/or management to the business. This change has the potential to significantly impact current customer relationships, production processes, the employee base and other critical aspects of the operations. The risks associated with integrating new ownership or management cannot be eliminated entirely, but they can (and should) be pro-actively managed.
10. There is no perfect time to begin
Business owners are always wondering, "Is now the right time to transition my business to new ownership?" There are a handful of factors which can impact the timing of this process, including:
- the competency of the current management team;
- whether the appropriate corporate structure and tax planning is in place; and
- the owner's personal acceptance of, and readiness for, this change.
Each of these conditions play a significant role in determining readiness and should be considered carefully prior to initiating discussions with third parties. However, one thing which should be avoided is the temptation to "time" the transition in order to maximize the value realized for the business. In this regard we note that:
- in a weak business environment owners will wait for market conditions to improve,
- in a strong business environment owners will wait until corporate growth has reached its peak, and
- in a stable business environment owners wait to see their current pet project or initiative come to fruition.
Indecision associated with the timing of the succession process often leads to repeated deferrals of any transition. As a result, the process is often ultimately forced upon the owner by health or external events. In cases such as this the owner loses all benefits associated with a deliberate and pro-active process (such as pre-sale preparation, negotiating flexibility, and sufficient time to evaluate all available options).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
