Articles
Early transition planning gets the best results
18-Apr-2007
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The way in which an exit is planned can affect much more than just the money value realized from the transaction. It can suggest what the best strategy would be; how to structure the tax liability on the proceeds to minimize liability; anticipate a number of obstacles that could delay the sale if not dealt with beforehand; and how to retain any ongoing role in it after transition (if desired). How an exit is handled can even affect the future success of the business itself.
There are too many business sales that prove disappointing because the owner wasn’t aware of better exit options or hadn’t foreseen the problems that would arise during the process and so were pushed into leaving under less than optimal circumstances.
If the business involves partners or other stakeholders whose individual plans for exit would impact the business as a whole, then it’s best to get these into alignment as early as possible to avoid any shockwaves when the time finally comes around. If Partner A has in mind to sell the business in five years, but Partner B wants to own and manage it with Partner A for 15 years, there’s a problem looming. A clear understanding of just how long each partner wants to stay in the business and what they expect will happen to the business when they leave can avoid a crisis situation developing around refinancing or buying out the withdrawing partner. |
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In family businesses it is often just ‘understood’ that it will transition to the next generation. What is not so often appreciated are the complications that can arise in putting this sort of transition into effect.
Planning will settle some of the hardest questions around family transitioning: do the intended recipients really want to take on the business?; do any of them have the talent, drive and entrepreneurial spirit to carry it on successfully?; will family transition set up the potential for conflict within the business or family?: how should shareholdings be apportioned between the successor and other family members?
Planning in advance will provide time to work through these issues and settle expectations or even begin mentoring or coaching the intended successors to suitably qualify them to take up their role.
Employees are a primary stakeholder group and highly instrumental to the success of a business. They are also key influencers of how smoothly a transition can work. If key employees are working on the assumption that an owner intends running the business for some time and then find a sale is planned they may be dissatisfied and disrupt the sale process – for example by leaving.
Expectations need to be managed and arrangement made to retain key people or the business could see a good proportion of its value walking out the door during the sale negotiations.
If the time comes when strategy directs that growth requires a business partner and/or outside financing from angel investors, banks or venture capitalists, the due diligence process they will run the business through will involve asking about the owner’s long term plans regarding the business, and specifically how long they plan to be with it. That will require a thoughtful response – best presented as a structured transition plan.
There are a number of transition strategies (selling to a third party, selling to management or employees, passing to heirs and many others) and each has pros and cons both as a strategy and with regard to the cost of implementing it.
A prearranged plan for a family transition provides leeway in which to develop the most tax efficient method of achieving the transfer. Only a very limited amount can be gifted to each heir each year without attracting gift tax and the tax implications of passing a business to heirs through the owner’s estate are daunting. If the plan is to share equity with heirs it helps to start early when the company valuation (and share price) is low and allow the longest number of years to pass the business on to children.
One of the most sophisticated and tax-friendly ways of selling a business can come from transitioning it to the people who already know it the best – the employees or management team as a management buyout (MBO). It’s not necessary to sell all at once to them - subject to agreement payment could be taken over time and shares that the business owner retains could earn a higher dividend or carry a higher value when they are eventually sold. However, the process of transferring total ownership to the employees or as an MBO, including the sale of the owner’s shares, is more easily accomplished and costs less when the process is started early.
Transitioning is just as much about strategy as setting up and running a business. An initial plan should be fleshed out early and reconsidered as circumstances or personal objectives change over time. Being prepared isn’t good advice just for Scouts. If there is a plan already in place then it’s possible to make the best use of circumstances - exit at a time of your own choosing, when the business is doing well and the market conditions are advantageous. But if that flexibility isn’t needed and the business runs full term then a plan is still essential to getting the best value with the least frustration from its transition.
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