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Thoughts on Small Business Succession and Sale


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Many small to medium-sized businesses face a challenge when it comes time for the company President or CEO to retire, or they wish to pursue other professional opportunities. With family businesses, there can be an added layer of complexity. This post is to outline some of the important considerations.

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Background. In the financial planning and investment advisory space, I see and learned about succession in two ways. First, when I make recommendations to clients about retirement and investment decisions when investing in or selling a business. Second, financial advisors are aging, and there are many smaller financial advisory practices without a succession plan. It is ironic that a group who advises on planning for retirement is often unable to prepare for their transition and retirement. However, it is not entirely their fault. In all nearly all sectors, small businesses do not have enough buyers and do not focus enough on grooming and planning for new leadership. It is tough and time-consuming to connect with buyers. Plus, there can be strong personalities and personal dynamics that make a plan or deal harder than with multi-billion dollar public corporations with boards of directors and outside shareholders. Finally, valuations are often much lower than mid-sized or public companies because of the higher risk. It is the norm for many to be valued using a low single-digit multiple of cash flow.

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Here are some topics to consider when evaluating a succession or sale.
A. The intention, desire, and ability of management. The following are various options: 1. “Pay me a check, here are the keys, I’ll be on the beach without cell service, good luck :)” 2. A transition and scaled back role. A manager handles the day to day decisions while the owner cuts back the time commitment and serves as an advisor to help with key decisions and preserve customer relationships, among other vital activities. If the manager is already working in the business, it is easier to evaluate their potential and groom them for this role — this can happen over the course of months or even years. 3. The CEO due to health or age can no longer fulfill the obligations and demands of the business. A CEO isn’t always sitting behind a desk from 9–5 and having a two-martini lunch. In this case — patience and time to plan or groom from within are not feasible. 4. The passion and excitement are gone, they are exhausted by the company/role, or developed a passion for doing something in a totally different field. The examples that come to mind include going back for education, charitable and humanitarian efforts, and a desire to tackle a different industry. An overriding consideration to all options is certainty the CEO ready to move on. Retirement, scaling back, or a new role is a big adjustment. It brings new routines, new people, different responsibilities, and different levels of control, to name a few. A substantial amount of thought should go into this. 
I start with this point because it dictates many of the other considerations an owner must make in a succession or sale situation.
B. Who to choose? Is the best person to take over someone from within the firm (or family) or someone from the outside? Is an internal person ready or can they be prepared in a reasonable amount of time? Will finding an external person alienate or drive a wedge between top performers and new leadership? Can someone internally provide fair financial consideration in an acceptable structure? If there a family member involved in the business this is the most delicate dynamic of all.
C. Family dynamics. A family business could face sibling rivalry — how to choose which sibling or child to assume the role. Is co-CEOs even possible? Will these decisions ruin relationships and holiday celebrations? How about determining fair ownership percentages for family members — does the CEO own more than a sibling with less responsibility working within the firm? How about in comparison to another family member not working in the business? Who has “the final say” on key decisions? What is a child’s ability to pay and maintain profitability and how does it compare to an external party?

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D. Style and culture. Different management styles and cultures can upset relationships and dynamics. Shaking things up, modernizing processes and technology, or being more flexible to attract young talent is needed to have greater success. But not all changes are for the better or work out as expected. If it causes strife, employee turnover — especially with loyal tenured employees — there can be serious issues. Examples include: switching the formality of the business setting, constant changes to see what works well versus extensive planning and one single decision, a meritocracy versus equality, and countless others. Even in situations where a CEO and owner is moving on or relinquishing control, they will remain attached to long-serving employees and to the organization they helped build.
E. Value, consideration, taxes, and transaction structure. Valuing a business is just as much art as science. There is no single formula. No two companies are exactly alike. It could make sense to offer a discount to a family member or a long-time employee. Consulting with trusted advisors can help — but accountants and lawyers are not always in tune with a specific sector, valuation adjustments, and current market conditions. In the case of an outright sale, the focus can often be the headline number. However, retaining stock could be valuable due to the future upside and possibly reducing taxes if received over time. When retaining ownership, there should be a healthy partnership dynamic while having a clear defined way to make key decisions. An employee successor or even external individual may not have the resources to present an all cash offer. An earn-out, or agreement to make payments based on a schedule or future company performance, can bridge this funding gap to reach a fair value for the business. Consult with a tax professional about any alternatives and options to limit taxes including a sale or retention of specific assets (e.g., real estate), a stock versus asset sale structure, determining a basis for a capital gain, and tax treatment of any future payments. There is no rule as to which structure will offer the highest total after-tax consideration.
F. Effort, secrecy, and marketing the company or role. Finding a successor or acquiror for a business requires a tremendous amount of energy. It will demand lots of organization to prepare documents and answer questions, meetings, and is a distraction. Working with an advisor or business broker can alleviate some pain points, but the CEO still must play a very active role. Sharing that a business is for sale can be nerve-racking for employees, distract management, and disrupt customer relationships if a transition is not well explained and planned for thoughtfully. No company is perfect and revealing struggles and bad attributes of a company can get emotional and critical. If employees or potential internal successor learn that the CEO is searching for a successor, can they maintain engagement and limit turnover? I think networking, candid conversations, and developing a rapport and trust are the keys in this area.

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Conclusion. As you can tell from reading these items to consider, some cases may work out to be linear — you could go right down this list, and the decisions are obvious. For other situations, it could look more like a matrix, or a decision tree with various “if this than that” alternatives. Please contact me if I can be of help if you are considering a succession plan or sale.

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CCM is searching for a small business (<$3 million in sales) in the Chicago or Milwaukee areas. If you know of an entrepreneur looking to retire/sell or pursue other endeavors and it fits the criteria described, please share this post or the file below containing more detail. Referral fees could be paid upon successful completion of a transaction.
https://www.dropbox.com/s/s3ew0cp2jn3fw6m/Small%20Business%20Succession%20Search.pdf?dl=0

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