Elements of a successful business succession plan

Feb. 1, 2012

At some point you’re going to leave your business. Hopefully, when you leave it’ll be on your terms. Understanding your options well before the day you leave your business is just good planning. And, good planning always helps you get a better outcome.

How you actually leave your business is part of what we call the exit planning process. It’s important to know that exit planning is a process and not an event. The steps to an exit process often include the following steps:

  1. Knowing whether you can financially afford to leave your business.
  2. Knowing whether you are mentally ready to leave your business.
  3. Understanding what the business is worth to different buyers.
  4. Knowing what the options are for transfer methods for your business.
  5. Increasing the value of the business for you and a successor owner.
  6. Using passive ownership strategies as a way to test your ideas about leaving your business.
  7. Understanding the likely successful transfer method of your business.
  8. Finding a successor owner for the business. (Or hopefully more than one successor)
  9. Going through the actual transfer process.

10.  Investing your proceeds.

11.  Planning for your family and yourself as an ex-business owner.

12.  Estate and legacy planning.

These 12 steps often take several years to accomplish. There is no rush and many people who begin an exit process will pause at different steps, sometimes for years.

At the same time, you need to realize that at some point you will actually leave your business.  The following four methods and one strategy are things we believe are the only macro ways for leaving your business.

Sell to an outsider?

You can sell your business to an outsider or a third party. This is where you sell your business to someone outside of your family or present business family. This buyer will either be a financial buyer, a strategic buyer or an intellectual capital buyer.

A financial buyer is someone like a private equity group. They will look at your business from what they can get as a financial return only. 

A strategic buyer is often the competitor you like the least. This buyer will take a look at your overhead as something they will cut after they take control of your business. The strategic buyer can often afford to pay more for your business than a financial buyer.

The intellectual capital buyer is the most rare of outside buyers. Most business owners have never identified what the intellectual property is in their business and have never commercialized that intellectual property. For those businesses who have taken this step, they will often get very high multiples of sales as a purchase price. The intellectual capital buyer is more interested in what they can do with the intelligence held within the company than they are with the actual cash flow from the company.

Sell to existing managers?

You can transfer your business to your managers. This transfer method is often satisfying to the selling owner. They get to see the business continue under similar methods as when they ran the company. Their stakeholders are often taken care of and treated well.

The problem with a sale to managers is that managers rarely have any money. This means the selling owner will be holding paper (or being the bank) for the sale. When an inside sale is done we recommend having the owner stay involved in the business until the note is paid off from the buyers. 

Many sellers will look at an Employee Stock Ownership Plan (ESOP) as a good way to structure a sale to managers. The seller can receive preferential tax treatment and all of their employees become successor owners of the company.

Sell to your kids?

You can transfer your business to your children. Today we’re seeing less and less children interested in taking over the family business. At the same time, for those families that want to do a transfer to family, the transfer can be very satisfying.

I recommend that a business is sold to children and not gifted to them. When a business is sold to children, the children will be making a decision that the business is a good one. They have committed to putting their own hard earned cash in the business (even if the money comes from business profits.)

An important thing to test before doing a transfer to your children is whether they have the ability to run the business. I have had the unfortunate experience of telling parents their children are not able to run the business. This is not a happy day for either the parents or the children.

Liquidate the business?

You can liquidate your business. This is often the default option for those who have not planned for how to leave their business. In almost every instance business liquidation, whether it be controlled or forced is not the best way to leave your business. You will often be left with less money and have more trauma along the way.

You really should consider passive ownership as a step along the way. Every business owner should consider passive ownership as a logical step along the path of exiting their business.

Passive ownership as an option

Passive ownership is where the selling owner completely gets out of the day-to-day operation of the business. A passive owner will have to install systems in the business that allows others to know what’s important in running the business.

Third party buyers aren’t interested in the selling owners, but they are interested in having people on board who can run the business. If the owner has made the transition to passive ownership they will often receive far more money for their business than if they continue to be involved in every aspect of that business.

There is no way to test managers and to see if they can run the business until you’ve become a passive owner. If you’re still making all the key operational decisions you will never know how good the next generation of owners are.

When an owner becomes a passive owner they now have the time and energy to concentrate on strategic issues that make the business much more valuable. This important step is the key to a successful business transition.

It’s your turn. Decide how you want to go through an exit process in your business. What are the steps that you think are most important? Take one of those steps and put an action plan together. Starting a process will lead to more steps. The more exit planning steps you take, the better the outcome is likely to be.