Over the next 10-15 years many baby-boomer business owners will need to decide how they will I transition out of their business. This blog series started with an overview of “Strategies for a Successful Business Exit“. this was followed with “The Business Exit Situation Assessment“, where I introduced the first element of my Business Transition Process that can help achieve a sustainable succession structure and a financially rewarding exit.
This blog will explore the second key element of the Business Transition Process – Business Transition Pathways. The goal is to determine which business ‘transition pathway’ is best for you and your business.
Business Transition Pathways
During my research, I conducted extensive discussions with business owners about transitioning into retirement. My key takeaway was the realization that there are many pathways and options to consider as small business owners approach their retirement or consider other possible business ventures. In my research, I concluded the following are five different business transition pathways to consider;
1. Do nothing- and pray
- Wind down – voluntary
- Wind down- involuntary
2. Sell Internally
- Family-same/next generation
- Management buy-out (MBO)
- Employee buy-out (EBO)
3. Sell Externally
- Strategic buyer
- Financial buyer
- Merger/Strategic partnership
4. Grow-and then sell
- Board chair-redefined C- Suite (external hires)
- Board chair-refreshed C-Suite (internal promotions)
5, Harvest-maximize cash withdrawals
- Sell non-core assets
- Review cost structure and defined program of dividend withdrawals
Do nothing and pray
A sad reality is many business owners do nothing but hope for a series of serendipitous events which will lead to the sale of the company and ultimately provide assured transition. Unfortunately, potential for such a buyer is remote at best, and is thus referred to as the ‘Hail Mary Strategy’. Inevitably, doing nothing leads to either a voluntary or forced wind down as opposed to the miracle sale one hopes for.
In terms of potential benefits, a voluntary wind down is the simplest strategy to implement. All assets are liquidated with proceeds used to pay off liabilities, while left overs are handed back to shareholders. A concern to note when deciding to wind down by a set date is that you may not get fair market value for current assets. There may also be many non-financial assets such as client relationships or brand reputation that have high enterprise value. Liquidating the business removes all intangible value built over a long period of time.
There are clearly no positives with a forced wind down, as it is more of a consequence than an action. As a result, the reality is that the company is neither solvent nor viable, leading to the commencement of formal liquidation through receivership bankruptcy. This the most stressful and difficult transition scenario as a company finds itself assailed by creditors. To return to a solvent state, urgent external capital injection will need to take place.
In short, “Do nothing and hope for the best” is not a good business choice.
Sell Internally
Among the owner’s family or current staff there may be someone well positioned to take over or buy the business. Proceeds may be a bit lower but knowing the buyer well should minimize unexpected headaches.
Keeping the business within the family has many benefits. The successor generation will likely have a higher inclination and ability to take over. The time frame of this sort of transition can be quite short, assuming interests of family members are aligned. Family successors also tend to have many years of grooming and preparedness for the eventual take over. The risk of the underlying deal structure collapsing as a result is much lower as there is significantly less due diligence required.
Another transition known as Management Buy-out (MBO) is the sale of the business to a team of senior managers with the motivation and resources to continue to manage and grow the company. This can be advantageous as legal and accounting fees are reduced. A management team, with experience in the business, is more likely to maintain intangibles such as: branding, culture and client/supplier relationships.
An Employee Buy-out (EBO) has a similar structure to a (MBO) but involves a broader group of employees. This usually involves a high level of shareholder involvement and can be advantageous as employee/investors will keep their jobs. This transition is usually difficult to achieve as it often follows some financial distress and is generally used as a last resort option.
Sell Externally
After examining options to sell or transition within the company, it is prudent to examine possible external buyers who may be interested. Options for mergers or strategic partnerships may also arise from this search.
There are many reasons why you may sell to a strategic buyer who is possibly a competitor, supplier or conglomerate looking to add to its portfolio. This opens a vast landscape of possible suitors to choose from giving you freedom to choose the most attractive fit. In this instance, it is important to note any unique industry competitive conditions that may cause more risk or danger if there are limited competitors within the industry sector. The challenge is to successfully identify and access such individuals or corporations with sufficient personal capital and/or resources to achieve a successful purchase.
Other potential buyers can come in the form of Private Equity Groups (PEG), otherwise known as financial buyers. These groups administer funds to invest in various geographic areas, many with a focus on retiring baby boomer businesses. These PEG’s often execute a ‘roll up’ strategy where they acquire numerous small companies and consolidate them into one larger entity. These sales often have long time frames in which a high level of due diligence is required, leading many deals to burn out. Over the course of this time frame, sensitive information may be discussed, requiring a Non-disclosure agreement (NDA) to protect and maintain confidentiality.
Transitioning the company externally may also come in the way of a merger or strategic partnership. A possible alliance or merger with an outside entity may exist as an interim step towards a formalized sale. Potential strategic partners may pay a premium if the company and or assets are seen to have strategic value or synergies.
Mergers can allow the selling shareholder to dispose of controlling shares, such as 50% + of the company in some deals and still retain sufficient shares to enjoy the upside of enhanced growth performance from the newly merged company. Even if there is only a share swap with no cash exchange, this could position the entity to be sold to another external partner with greater valuation because of the initial merge. The harsh reality, however, is that equal mergers are rare and one side typically ‘wins’ and assumes power.
Grow and Then Sell
The “grown then sell’ concept idea stems from a survey revealing that fewer than 50% of business owners intended to grow their business despite approaching typical retirement age. This led me to think that many business owners might choose a pathway that emphasizes the importance of developing incoming (external) or upcoming (internal) talent to continue to build the enterprise and the business.
Externally, this can come in many forms such as an outside hire as a replacement CEO and potentially other executives. Typically, the owner steps down to take a board seat while providing strategic and operational oversight to the new management team, presenting a new governance structure moving forward. This ‘hired gun’ pathway is meant as an interim step on the way to eventual sale, and can often refresh corporate strategic direction, enhancing revenue performance along with possibly higher valuation. There are things to consider, however, such no cash liquidity would be provided to the owner for selling or winding down. There can also be issues with chain of command as boards tend to micro manage newly appointed CEOs and management team.
This grow-and-sell pathway can also be executed internally through building strength from within by developing a younger generation management team. As the transition progresses, it is important to allow the next generation to take over management and for existing executives to assume greater oversight responsibilities. This gives the business owner the opportunity to continue working with management they are familiar with. With this option, the owner will not enjoy the immediate cash liquidity from the sale of the company, and there may also be inter-generational challenges as the ‘old guards’ are replaced with a younger executive team. It is interesting to note that many senior level management positions are filled from the boomer generation. This outflow of retiring talent will have serious future repercussions in terms of consumer demand and business continuity.
Harvest – Maximize Cash Withdrawals
Lastly, if after all attempts to sell the company have either become problematic or unreasonably drawn-out, it may be in your interest to maximize cash withdrawals. This can be done through ‘harvesting’ cash through the sale of non-core assets (real estate) in the effort to maximize cash withdrawals while avoiding long term contractual commitments or cash injections.
With the “Harvest” pathway, the sole focus is on the core cash capabilities of the business, through lean and concise decision making and financial reporting. All non-core assets (for example, subsidiaries, other investments or redundant operational divisions) may be attractive to other buyers, or real estate can be sold to generate cash infusion. All other assets are dismantled, including low margin products, high maintenance-low return clients or unprofitable product lines. The proceeds can then be withdrawn by the owner or reinvested to promote further revenue growth as a prelude to future sale.
Another option in the “Harvest” pathway is to critically examine the organizations structure and reduce operating costs where appropriate. This would occur if the search for a buyer is ongoing and unsuccessful despite a demonstrated capability in generating attractive cash flows. It needs to be clearly recognized that this option limits potential growth and with that, attractiveness to potential buyers. Overzealous cost cutting may also influence employee morale as the business slowly and inevitably winds down. There may be a last-minute sale with far less than expected proceeds but in most cases the doors ultimately close.
Next Blog – Transition Plan Development
In my next blog, I will review the third and final element to achieve a sustainable succession structure and a financially rewarding exit – Developing and Implementing a Transition Plan.
Mike Thompson
Mike Thompson is a Fellow, Certified Management Consultants (FCMC), Associate Faculty at Royal Roads University and co-author of Business Diagnostics, a business book providing a simple methodology to size up a business.
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