Eubel Brady & Suttman Asset Management, Inc

In our last blog, we identified hurdles that often lead to procrastination on business succession. We will revisit those hurdles and offer strategies to overcome them. In doing so, the primary strategy to counter succession procrastination is to (1) recognize this is a long-term undertaking and (2) learn all you can from those who have been through the process before.  

For Many, Business Succession Is A Once In A Lifetime Event.

Unlike politics or a lenient teacher, many business owners do not get a second term or a second chance to sell or transition a business. There are hours of homework to do and many have stumbled simply because they get overwhelmed with the basic question of where should I start.

Author Rick Rickertsen attempts to cover everything but the kitchen sink related to selling a private business in his book Sell Your Business Your Way.  Despite the 250 pages Rick expends on the topic, there will still always be something new and unique that comes up. Experience comes directly from living through a succession event and incurring a scar or two along the way. Reading about the experience of others, be it stories behind successful accomplishments or outcomes that fell short of a desired result, can help you carve out a path for your ideal state succession blueprint. Succession is a journey that requires ongoing focus and can take years to envision, plan, prepare and execute. Realization of a defined ideal state is much more likely if you deal with succession incrementally and as an ongoing process as opposed to a list of to-do item(s).

Natural Behavior – Know Thyself Behaviorally.

A couple of years ago, a group of business owners looked both surprised and confused when a succession coach pointed a mirror at them to show what he viewed as the number one roadblock to succession progress. In fairness, it is not the business owner that hinders progress. Instead, it is their natural behavior that creates difficult hurdles during various phases of the succession process.  A business owner’s natural behavior is often a poor fit with required tasks, such as: Defining a future where his/her self-image is separated from the business; Sharing personal customer or vendor relationships developed over decades critical to the value of the business; Garnering the patience to mentor future leaders; Having a difficult conversation with a blood relative about a gap between their perceived and actual potential for a key role; or Answering to a new owner during a transition period.  This leads to procrastinating on what might be the best path for the owner and his/her business. 

The journey to know thyself behaviorally will not all be with the wind. At times, an owner may feel like he/she is on Mt. Washington in New Hampshire in the winter months. Achieving a well-crafted succession blueprint requires self-awareness to manage your own behavior at various stages of the succession process. 

Lack of Time – Succession Must Be A Priority.

Eubel Brady & Suttman follows an ongoing discipline to review, reset, establish priorities, plot out plans and execute what is perceived to be the most important initiatives to move the business in the defined direction. It is not uncommon for any business to overestimate the capacity to achieve priorities within established time frames. The greater number of outside influences (customers, competing personal interests, vendors, regulators, suppliers, professional partners) that can re-route a daily plan, the greater the chance succession will fall in priority. 

There is a tendency to procrastinate important things if there is not a commitment to prioritize a goal. When we are deeply committed, we find the time to devote to that priority. Implications of procrastinating on succession priorities are often hard to see over the horizon that is the future. These implications are easy to ignore when urgent but non-critical items end up absorbing your time. It is a pain in the backside, but pretend you are a lawyer and track your time; we will wager that you will be surprised where your time goes versus your plan. 

Succession is similar to saving money in one respect. The longer you wait to start, the more difficult the hill is to climb. Taking advantage of compounding, what Einstein described as the eighth wonder of the world, goes to those who get in the starting blocks earliest. Time is on your side with compounding and the same is true with succession.

A Clear Successor Helps To Visualize The Future of The Business.

A successor that has the competence to lead can be quite elusive. This is particularly true when the search is happening at the same time the transitioning business owner is obsessing over the health and success of the next generation of his/her privately held business. If the desire is to keep control of the business within the family, I have seen long standing plans come apart in weeks if the chosen leader reconsiders. This was the case when the third-generation successor designee decided his wife’s successful business needed to be the priority for his family. This forced a quick pivot to an ESOP sale once he told his father of his change of heart. These things happen and can change long-term crafted plans in a matter of days or even hours. 

Clay Mathile, the successful entrepreneur who grew the value of Iams Company to realize an eventual $2 billion sale to P&G, credits the professional management he brought on to his board and to his operational management team as key factors in enabling him to achieve the economic success he realized. Private business owners struggle to defer to others with experience and knowledge about their business and unknowingly limit the possibilities for their companies. An advisory board or formal board deep in experience with issues that are on your chosen path of succession, can increase your batting average of success. 

Two fundamental tests to determine whether the right successor is in place include (1) measuring the value of the company as a third-party buyer would and (2) the ability of the company to run without the daily involvement of the transitioning owner.  The goal is to avoid a third-party buyer determining a business has no real value beyond the hard assets because the cash flow of the company is dependent on the transitioning business owner. 

Standard of Living Needs Often Impacts Succession.

A succession plan requires an evaluation of the needs of the transitioning owner.  If the owner’s standard of living is high, this may cause him/her to anchor on a sale price that must be achieved, even if unrealistic. Alternatively, a better approach is to determine the standard of living that is achievable from the assets available.  Projecting a value for the business and the net proceeds that could result from a sale is a starting point. Coupling this with other assets or inheritances and other post-business exit income, can provide the groundwork for determining if a specific standard of living level is achievable. This might include charitable giving, future family generations trust funding, education funding, or other priorities that can be achieved by the selling owner at various sale prices and investment returns levels. Lately, an inflation rate for the future has become a much more relevant variable in this modeling given the impact on future purchasing power inflation has.

Proceeds from the sale or transfer of ownership in a business carries with it re-investment risk. Even residents of states that have no state income tax pay a fairly good chunk of sale proceeds to Uncle Sam. One should consider utilizing a portion of the liquidity generated from a sale to invest in assets that can generate income.  

One must also be mindful of lessening the risk of realizing a permanent loss of capital. This is critical because often highly competitive prices are paid for businesses at a time when other assets, such as publicly traded equity market valuations, may be elevated compared to long-term average valuations. Thus, caution should be taken as you reinvest your proceeds to lessen the chance of someday realizing a permanent loss of capital.  As a real-life example, if you sold your business in the year 2000 and reinvested the proceeds in some of the well-recognized technology growth stocks at the time, if you needed to sell some of those shares today you may experience a permanent loss of capital of 20-30%. 

Next time we will look at a few succession options for the transition of a closely held business.