Every Business WILL Transition
Understanding your Transition Options will help guide you toward a successful outcome.
One of the basic truths that we live by at Mastery Partners is every business will transition. Even the largest companies in the world transition - think about the transition from business icon Jack Welch to his successor in 2001. That was very much a business transition, and GE spent over 7 years thinking through the transition process.
I’ve often wondered why most small business owners don’t give more time and attention to their business transition - because, like it or not, it’s coming someday. The more time a business owner devotes to transition planning, the more successful the outcome will be.
Many business owners think that there are only a few options to transition a business, but as it turns out there are many. Let’s break down the transition options into three major categories: Internal Transitions, External Transitions, and Other transitions.
Typically about a third of business owners are interested in a sale to insiders. A transfer to insiders is arguably the most successful transition available to business owners today, primarily because it reduces risk and provides significant benefits to the insiders who take on the business. However, there are risks to internal transitions as well. The three primary types of insider transitions - a sale to family members, a sale to current management, or a sale to employees or ESOP.
Transition to Family: Despite the challenges inherent to a family transfer, there are many offsetting rewards and benefits, which are the results of careful planning. However, there is also an enormous risk to this type of transition - because only 30% of transitions to the next generation are successful - leave a whopping 70% failure rate.
Advantages: If family members have been involved in the business, they will already have knowledge that can help them be successful. It’s a great way to leave a family legacy, and can be a very favorable way to transfer family or generational wealth.
Disadvantages: Many times the “buying” generation wants to do things differently to leave their mark - which sometimes rubs the “selling” generation the wrong way. There may be family communication issues that need to be resolved. Sometimes, family members not inside the company may feel slighted. And, typically a transition to family provides a lower financial value to the seller.
Transition to Management: This type of transition is commonly referred to as a Management Buy-Out or MBO. In an MBO, the current management secures funding from a bank, investment partner, or the current owner.
Advantages: The advantage of this type of sale is the security of having well-seasoned management who already know the business. This provides a level of security for the business owner’s legacy as well as future payments to the business owner or new investors.
Disadvantages: A key disadvantage is the need to secure funding and many times, the current management does not have the ability to do so without help from the current owner.
Employee Stock Ownership Plan: A small percentage of business owners consider an ESOP exit strategy. This path is particularly appealing to those who wish to transfer their companies to known entities, perpetuate their current mission or culture, and keep their companies in their communities.
Advantages: Rewards your current employees and management by providing ownership in the company. Typically, the owner can stay involved in the business post-transaction, which allows them to continue long relationships with employees, vendors, and customers - which ultimately retains the business owners sense of belonging
Disadvantages: ESOPs are somewhat complicated to navigate. The business owner and employees will need to seek outside help which can be costly. The business will need to be able to borrow or find investors to pay the owner at closing, and many times, the owner carries a long term note from the company, even though they may not be involved in the day to day operations of the business.
The majority of business owners (close to two-thirds) are interested in this selling to a third party. A third-party sale is often the easiest and most financially rewarding option for business owners.
Sale to Individual Buyers: For very small businesses, the most likely buyer is an individual, sometimes with industry experience or specific interest in the market served by the business.
Advantages: Individual buyers might keep the business owner’s legacy alive. The individual may have industry experience allowing for a smooth transition. The owner may be able to stay on for a long term consulting agreement providing additional cash flow as they transition to the “Third Act.” Also, individual buyers may have a shorter due diligence process than other types of buyers.
Disadvantages: Individuals may not have the ability to pay cash or be able to finance a transaction therefore potentially requiring owner financing. And, the individual may not have industry experience typically causing a longer transition period whether the owner wants to stay or not.
Sale to Financial Buyers: There are several types of financial buyers such as private equity firms, venture capitalists, and family offices. These buyers typically have the cash to invest but don’t always have industry experience. Financial buyers will ultimately want to grow the business and sell it again at a future date.
Advantages: Financial buyers of all types are experienced at business transactions and so for the most part, they will know what they are doing. They will typically ask the owner to stay on and retain some ownership so that they can have a “second bite of the apple” when the business sells again. Many times, financial buyers will pay the highest price for a business, mostly because they have committed capital that needs to be deployed and put to work for their investors.
Disadvantages: Financial buyers sometimes don’t have specific industry experience, and therefore are not particularly helpful with operational issues and challenges. Usually, they do have a panel of people that can help but make no mistake, they are about driving higher revenue and profits because they will eventually sell the business again. Financial buyers will have a higher level of scrutiny on the financial performance of the business, even if the owner stays on in a key role, which they sometimes require.
Sale to Strategic Buyers: A strategic buyer is usually a larger company that has some reason they want to buy another company - usually technology, product or customer base. They also usually are entrenched in the same industry as the company, but may also be in a related industry and looking to expand into the company’s market.
Advantages: By definition, strategic buyers have a specific strategy in mind when they complete an acquisition, they are frequently the highest offer for the business netting the owner a higher value outcome. In most circumstances, strategic buyers know a great deal about the business and are buying it for strategic reasons. Therefore, they have great industry experience and can contribute really meaningful input. Many times, a strategic buyer is also interested in the owner of the business and therefore may offer a short or long term employment agreement providing additional income and security. For owners looking to walk away quickly, strategic buyers are a great option because they already know the business and market.
Disadvantages: Because strategic buyers are likely in the same or similar business, they may not need all of the former overhead, so some of the employees may lose their jobs and facilities may be closed. For business owners that personally own their real estate, if the buyer decides to vacate the property, the former owner may not be able to find another tenant for the space, thus reducing future income potential. If a transaction with a strategic buyer falls apart, that buyer will have tons of information about the acquisition target that could negatively impact the business - although this can be mitigated with a solid non-disclosure agreement.
Initial Public Offering: An IPO is a sale to the public markets typically through one of the stock exchanges, or more rarely by purchasing a “shell” that is already public. IPOs are typically reserved only for fast-growing businesses that have reached at least $100M in revenue, or for disruptive businesses that have raised significant investments already and have attracted lots of attention - and therefore only a tiny percentage of business owners consider it a viable exit option.
Advantages: There may be a capital infusion to the company for new stock issued that can be used for R&D, growth, or debt reduction. There is also a financial benefit to the business owner and early investors who can liquidate their formerly illiquid asset. Often generate publicity by making the company and products known to a wider potential swath of customers.
Disadvantages: IPOs are really expensive and business owners will need lots of help from experienced service providers and professionals. There are increased reporting requirements, not to mention added scrutiny of the Securities and Exchange Commission. And, Companies going public have to invest in things they may not have previously considered - like the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
OTHER TYPES OF TRANSITIONS
Although technically other options might be considered either internal or external transitions - there are a few that just don’t fit neatly into one of the other categories. They include often-overlooked exit strategies that could be viable options for business owners.
ROLE TRANSITION: Perhaps one of the most overlooked exit strategies might be considered no exit at all. A role transition from Owner/Operator to Owner/Investor is where business owners retain the management and ownership of the business - but stop working in the business day-to-day. This is an excellent option for businesses that produce high cash flow and for owners that can genuinely hand over the reins and learn to manage like an owner rather than an operator. It’s also a great option if both the company and the business owner are in great health.
Advantages: The business owner retains the benefit of the high cash flow, and they can potentially keep or add significant fringe benefits. If the business already has a great second-tier management team in place, the transition can be easy and seamless. And, the business owner ultimately retains control over the asset they started or built.
Disadvantages: Many times this transition is hard for business owners that have been heavily involved in the business for a long time. If internal management candidates are not available, the business owner will have to recruit and train new managers to run the business. And, finally, some of that high cash flow will need to be invested in the new management for compensation and incentives
LIQUIDATION: Fewer than one in five business owners view liquidation as a viable exit strategy. Except on rare occasions, liquidation is preferable only to death as a means of getting money out of the business. Without any planning, however, liquidation may become the owner’s only viable option.
Advantages: The business owner stays in control of the process, and can sell assets over time or at a planned time to close the business.
Disadvantages: The business owner may not be able to find buyers for all of the assets. And, liquidation can be a long and laborious process.
DEATH: Finally, let’s just mention my least favorite transition option which is the death of the business owner. Although I hated to add this one to the list, unfortunately, death becomes the default exit option for too many business owners. It is almost always the worst possible outcome because the business is left to the typically inexperienced hands of the heirs or employees - with no plan for what to do to keep the business viable.
Advantages: The only advantage to this type of exit is that the business owner is no longer burdened with the business because they are no longer around.
Disadvantages: The heirs may need the cash that the business formerly generated in order to survive. (Notice I said formerly because, without the owner, the business almost always declines rapidly.) The business is left to the heirs to decide what to do, and most of the time they have no experience in the business, and therefore it may have to be sold in a fire sale or liquidation - which will generate far less value for the heirs.
In the end - it is so important to explore all of your options, and decide which direction the business owner wants to go. Only then, can they build a strategy to get there, and execute it like their future depends on it. Because it does!
Remember, ALL businesses will eventually transition. The earlier you start planning, the better your chances of transitioning your business on your terms.
So, stop right now, and consider all of the options outlined in this article. Which one would you choose for your ideal outcome? Once you know that, it’s a good step toward defining your exit strategy. And reach out to us and we’ll give you some FREE resources to get started.
What are you going to do today - to Maximize Business Value? Call me if we can help you in any way!
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Check out this week's Maximize Business Podcast on the same subject:
About TOM BRONSON:
Tom Bronson is the founder and President of Mastery Partners, a company that helps business owners maximize business value, design exit strategy, and transition their business on their terms. Mastery utilizes proven techniques and strategies that dramatically improve business value that has been developed during Tom’s career 100 business transactions as either a business buyer or seller. As a business owner himself, he has been in your situation a hundred times, and he knows what it takes to craft the right strategy. Bronson is passionate about helping business owners and has the experience to do it. Want to chat more or think Tom can help you? Reach out at email@example.com or check out his book,Maximize Business Value, Begin with The Exit in Mind(2020).