Eubel Brady & Suttman Asset Management, Inc

Like the door 1, 2 and 3 choices of the popular 1960-70’s era game show Let’s Make a Deal, there are three generic doors to choose from in the business succession game. You can (1) sell your business to an unknown third-party buyer, (2) transfer/sell your ownership interest to a family member or hand-picked successor, or (3) close the business and liquidate assets that have economic value.  Frequently, what appears to be a successful business will announce they are closing their doors. This may be the result of a failure to make succession planning a priority. Sometimes, the hidden risk that determines the survivability of a business only comes into view when a premature passing or an unexpected health situation comes on without warning.

Sale of The Business:

Doors 1 and 2 above can have multiple sub-options that can be a fit depending on the priorities driving your succession planning. The list of sub-options is voluminous and may include:

  • Full or partial sale to a next generation
  • Sale to management where you maintain an interest
  • Full or partial sale to employees in the form of an Employee Stock Ownership Plan (ESOP)
  • Sale to a strategic buyer (situations where a business needs improvement in an area that is a key success factor like technology for example)
  • Full or partial sale to a financial investor such as a private equity firm or family office
  • Sale to a buyer who is looking for a new challenge (we see this frequently in a business that is a passion for a hobbyist/investor who has left another career but needs a new challenge)
  • For larger companies with significant profitability:
    • Initial Public Offering (IPO)
    • Acquisition by a public company

Many of those options will involve a selling owner leaving some equity in the business or remaining involved as a consultant for a period of time. 

Assessing the fit of the partial list of options above within a business owner’s priorities is something that can be a challenge. We utilize a personalized succession blueprint tool to help identify top priorities when developing a plan. A few quick examples may be of help here.  Let’s say an owner’s blueprint prioritizes keeping jobs in communities where he/she now operates, potential tax savings, and an opportunity to allow employees to become owners.  The owner may explore a sale to an ESOP trust. However, ESOPs generally require a trusting and open culture, reliable cash flow to service the debt, and fees to administer the ESOP can easily run to six digits annually.  Despite the owner’s priorities, these limitations may cause an ESOP to be a poor fit for some companies.

Another owner may prioritize bringing on a partner with contacts and industry experience, capital to fund future growth, and a partial sale that diversifies the owner’s net worth. The owner may explore a partial sale to a strategic buyer or partnering with a financial investor. However, adding an owner will likely require a more formal approach to governance of the business, ceding some control with board seats or operating and capital budgets, and/or involve restructuring incentive plans for senior management. The loss of autonomy in managing the business may not fit within the owner’s vision of transition. For the business owner who has done it her or his own way, it is difficult to describe the possible reduction in general satisfaction and personal engagement that can result from the behavioral changes a new financial partner can push for when arriving at the ownership table.

Winding Down The Business:

Under certain circumstances, the door 3 option of winding down the business may be the best choice. For example, the owner may need to grow the business to realize economic value.  This often requires more investment in working capital. However, the money may not be available, or the owner might be unwilling to take any risk to reinvest capital in the latter stages of his or her career. It may also be a situation where the owner’s individual labor and commitment is necessary to generate value from the business. Given the behavioral needs of autonomy and independence that business owners often have, answering to a boss after spending years as an individual owner/operator is just not practical.

Considerations In Choosing A Path:

An effective succession plan must include a conscious choice among the three generic options.  In his book, Sell Your Business Your Way, Rick Rickertsen discusses an inside versus an outside sale. About 10 years back, our firm worked with a second-generation business owner who received an unsolicited purchase offer from a publicly traded company. The business owner had taken control of the business from his father and increased its value with a sales growth strategy following a couple of very tough years around the great recession.

Our client quickly learned that selling to a sophisticated acquirer requires navigating a due diligence process that can be stressful and last for weeks or even months. It was a major distraction to running the business. Answering what seemed like an endless stream of due diligence questions created stress and weighed on his psyche since he was on new ground from a personal experience standpoint.  It was difficult for a fast-paced entrepreneur to work through a due diligence phase of the purchase that seemed to never end. The owner struggled to understand which requests were strategic and could impact the valuation price and which ones were “check the box” items that any prepared buyer needs to complete.

Between the experience of the seller’s attorney and my past experience working for a company that was purchased by a large public company, we were able to share insights on what requests were important. This helped ease the owner’s anxiety.  We explained that whether the sale is to an outside buyer like a public company or an inside sale like an ESOP or a management group, completing checklists to close a transaction will be more like a marathon than a sprint.

Whether before or after you identify your succession priorities, a critical reference point for developing your succession plan is to obtain an estimated value of your business.  This is true whether you want to execute an inside or an outside sale. An investment banker or broker that knows your industry can get you to a reasonable range of value for little or no cost. However, you can expect to be hit with some aggressive follow-up until you sell your business because bankers who do not ask for a retainer make most of their money when the sale occurs. A formal business valuation is an option as well. In a future blog we will talk more about the skillsets we believe you want with you at the negotiating table depending on the circumstances around the sale and the type of sale. For sales to a targeted successor, internal management team, or an ESOP, the valuation is a critical piece since if gives the seller insights into the level of discount you are providing to successors who are more likely to cooperate with your vision of how the business carries forward to its next generation.

Information presented is for educational purposes only and should not be construed as tax or legal advice.  Please consult with your tax and legal advisors before engaging in any transaction.