This article is the first of series that breaks down the steps a business owner can expect to encounter when he decides to sell or transfer his business to the next generation.
This series breaks down the sale of a business into three distinct phases:
- Phase 1 or the Infancy Stage – the business owner (the “Owner”) starts to think about his succession plan and begins to prepare for Phase 2;
- Phase 2 or the Childhood Stage – the Owner proceeds down the chosen path towards the sale/transfer of his business; and
- Phase 3 or the Adulthood Stage – the Owner sells his business and fulfills post-closing obligations, if any.
Phase 1: Infancy
In the next 10 to 15 years, approximately 12 million businesses owned or control by the baby boomer generation will close or change hands. A 2016 survey of small business owners found that 90 percent of small business owners anticipate selling or transferring their businesses, as opposed to closing them. This same survey found that 72 percent do not have a current succession plan and are not taking any action at the moment in anticipation of a sale.
Owners must first sketch out potential transfer options. There are countless ways to structure a transfer, but some of the most common are:
- Transferring to children that are active in business;
- Purchase by a current management team; or
- A third-party sale.
Owners must also decide what role they see themselves taking on post-sale. The Owner may wish to retire altogether, stay active but transfer all or most of the ownership, or the Owner may desire to remain with the company in a reduced capacity for a period of time. Often times the Owner takes a role as a transition consultant while retaining a piece of ownership for a potential second bite at the apple.
As the Owner begins to formulate succession options, there are some steps the Owner should take to maximize the value of the business and facilitate a smoother transfer. The company’s books and accounting records for the past three to five years should be in order and prepared in a consistent manner, and the Owner should discuss with his accountants the possibility of a transfer or sale. The Owner should take a thorough look at operations to determine if there are efficiencies not being utilized. The Owner and his attorneys should review material contracts and the Company’s compliance with laws. Phase 2 will touch more on these issues, but it is crucial that the Owner begins to think early in the process about all the various facets of the company that a potential buyer’s due diligence team will scour.
As the Owner begins to formulate his succession plan, it is imperative that he brings the right team to the table. Engaging qualified and experienced advisors in Phase 1 is crucial to the success of a sale. The right investment banking team can add significant value to a deal by determining the fair market value of the company, guiding the Owner through the transaction, and locating potential strategic buyers or private equity buyers. Experienced M&A attorneys help the Owner navigate each turn in the arduous sale process and strive to minimize the Owner risk while maximizing value. Lastly, the Owner should confirm that his accounting firm has relevant M&A experience to ensure that the deal structure is tax efficient for the Owner and that the firm can assist with the transaction as needed. Rather than focusing on price, Owners contemplating a sale should concentrate on the value that each advisor brings to the transaction.
Lastly, the Owner needs to step back and determine what they want from a transition and what they need. A seven-figure sale price might not be sufficient for an owner in his early sixties if he was previously taking a generous salary and regular distributions from the company. Factor in taxes, the cost of healthcare, and the Owner’s retirement dreams and what the Owner needs from a transfer may be different from what he gets for his business. The sooner the Owner’s goals and necessities are determined, the quicker the Owner and his team of advisors can chart the path toward realizing those goals.
Next month’s blog will discuss Phase 2 – Childhood and Adolescence. Phase 2 consists of finding the right suitor, preparing for and surviving due diligence and negotiating the deal terms.