As a member of the Baby Boom generation, I am advising more and more Millennials who are exploring business acquisitions; primarily involving companies owned or controlled by my Boomer peers. A majority of the estimated 15 million privately owned business in the United States are owned by people born before 1964, and the Small Business Administration (SBA) estimates that around 10 million baby boomer-owned business will change hands in the next few years.
Our young entrepreneurial clients are looking for opportunities to acquire Boomer-owned businesses where they can add their unique expertise in technology, social media, or marketing. However, finding businesses to buy that represent attractive growth opportunities isn’t easy. The process requires patience, diligence, and talking to lots of potential sellers before finding an opportunity worth pursuing.
According to a recent family business survey by PwC, two-thirds of family businesses don’t have a documented and communicated succession/transition plan. Only a minority of these small businesses are ever listed for sale with a small percentage actually selling, and even when diligently pursued, very few transactions actually close.
On the potential seller side of this equation, we have also been assisting Boomer-led companies with succession planning – transitioning ownership from founders to younger partners or key employees over time – in lieu of an outright sale. Although we certainly work on family business transitions, founders often have no interest in transitioning ownership to family members (or family members have no interest in the business) and have decided the best option is to sell their business to employees.
In some cases, those working in the business have a better understanding of how it operates. Employees know essential details like key customers and suppliers, and founders prefer leaving their businesses to experienced parties who are better able to ensure future success. In other cases, founders prefer a stream of continuing income from the sale vs. a lump sum from a third-party and are willing to offer financing incentives to their employees. There are also cases where businesses have an established association with their founders. In such situations, founders often want to position their former employees for continuing success, leaving a legacy that will remain long after they are gone.
Regardless of the reason, developing a good transition plan is vital to ensuring the continued success of any business whether founder retirement is near-term or 30 years away. There are four key components of a good succession planning process, summarized briefly as follows:
Initially, this process encompasses both external and internal assessments, including an operational assessment of your business and your team members; identifying significant business challenges in the next few years; identifying critical roles that you will need to fill both internally and externally, especially if founders currently fulfill these roles; and identifying all institutional knowledge, technical competencies and relationships that are critical to retain or develop in the business over the next few years. A financial assessment is also crucial in understanding any trends or financial risks inherent in your current business model, as well as any tax implications that constrain or dictate the structure of a potential transaction. Finally, a legal assessment. Business founders must review corporate and transaction documents, including loan agreements, guarantees, purchase contracts, leases and other documents which could be impacted by a change in control of the business over time.
The next step involves a candid evaluation of your existing team members gauging capabilities and development potential over the next several years. Who is ready to step up as a key leader in this process? Who has or can develop the “owner’s” mentality necessary to move the business forward after founders are gone? Moving from an “employee mindset” to an “owner’s mindset” is a major change in thinking. Not everyone is prepared to make that transition without significant coaching, and some may never be ready.
Another part of the Evaluation phase involves using a formal or informal valuation exercise to calculate two important factors: the realistic value of a business and financing terms that work for both the sellers and potential purchasers. Detailed financial projections are required to determine realistic assumptions over the transition’s desired timeframe without adversely affecting the ability of the business or the new owners to cover overhead and required debt service as well as unanticipated changes.
Once the parties have a sense of where the business is today and where it needs to go to satisfy the needs of the selling founders within the financial ability of the purchasing employees/partners, the next step is to evaluate various structures from an operational, financial and tax standpoint. Estate planning considerations for both the sellers and the purchasers are also important since unanticipated events can have dramatic impact. This part of the process is all hands-on board with attorneys, accountants, financial and insurance advisors. For some transactions, insurance can play a key role in a transition depending on the individual needs of the parties.
Once an appropriate structure has been developed and transition steps identified, it’s time to implement. In some instances, this is done in a single major transaction, much like a third-party sale. However, in most cases this is part of a well-designed multi-year plan which anticipates and incorporates significant flexibility. Often equity is transferred starting in small steps, with opportunities to reverse course if either party isn’t comfortable with how things are progressing. If documents are properly structured from the beginning to anticipate changes and provide flexibility, the transition process can move forward relatively smoothly with an end result that both founders and new employee owners will be happy with.
Whether you are considering the sale of your business or potentially transitioning partial or full ownership to family members or employees, our business law team at Milgrom & Daskam stands ready to assist.