Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
1, Internal ownership transitions may give existing employees a chance to carry the founder’s culture on into the future, but such a strategy is unlikely to bring about the maximum financial return on the sale.
2, To determine the best transition strategy, follow a defined process that starts with identifying what the owner requires, from a financial standpoint, to enjoy financial independence.
3, Despite the likelihood internal buyer or buyers may lack capital for a traditional exit, there exist several formulas under which such transactions can happen. Consult advisers to help determine your best plan.
4, An outside calculation of business value is essential for planning and will indicate if value enhancement steps are necessary or if the owner could retire now.
Reality is that at some point, every business owner will experience an ownership transition. Demographics alone contributed to the wave of business transitions prior to the onset of COVID-19. On the pandemic’s heels, baby boomers continue to retire and transition ownership of their companies in record numbers. The pandemic only accelerated the trend as entrepreneurs take stock and pursue new life directions.
For some, this newly gained perspective reinforces a commitment to pursue an “internal” ownership transition strategy — one that allows key employees, family members, co-owners or a combination thereof to step into ownership, to experience the “American Dream” more fully. This is despite the perception that most owner’s ultimate dream is to sell for top dollar, for a 100-percent-cash deal, on their own timetable! In the exit planning field, we define this as a “pipe dream,” not a real “plan.” Those sorts of exits rarely occur.
So why do business owners decide to put the “pipe dream” aside and turn their attention toward identifying an internal transition strategy?
There are three primary situations, not inclusive, that tactically lend themselves to an owner pursuing an internal transition strategy.
First, they have already determined and reached financial independence without need for any proceeds from the sale of their business. Statistics indicate only 16 percent of owners find themselves in this enviable position.
Secondly, these owners have afforded themselves the advantage of time. Time to explore, design and finally implement their exit strategy, important because internal transitions typically take five to 10 years to complete. During this time, the owner can stay active or not, while always retaining control of the company.
And finally, internal transitions are often the result of owners recognizing that alternative strategies, i.e., an outside sale, are not feasible, either due to the size of their company, market demand and/or company readiness. Educating owners on the difference between a “lifestyle” and “transferable” business typically ensues. See article in Oct-Nov 2014 Upsize Magazine.
Aside from the tactical reasons for choosing an internal transition strategy, there exist numerous emotional reasons that owners pursue this path. Owners often want to give their key performers the same shot at financial security that they have enjoyed. They want to reward key performers for helping them grow and build the business or are interested in motivating their team to help them build enterprise value.
They may even be honoring a vague promise uttered along the way that “someday this will all be yours.” Or owners sometimes believe the only way to maintain a company culture is to transition ownership to individuals already working in the business — those who understand the values, customers, vendors, operating processes, etc., and that helped establish the business’s success. Whatever the reason, tactical, emotional or a combination, internal transitions have one major challenge to overcome … lack of capital.
While recognizing, even accepting, that selling for maximum price is unlikely with an internal ownership transition strategy, short of giving it away, how can owners accomplish their objectives and still gain economic advantage for their life’s work?
The most common internal exit strategies include the following:
While space limits an extensive review of each, suffice it to say that they all carry advantages, disadvantages and situational fits. The goal is to educate owners on their options, help them evaluate which best meet their unique objectives and risk tolerance and to formulate an intentional plan, in writing, directed by an action checklist.
Where is an owner to start? In my experience following a defined process proves most advantageous and increases the likelihood of ownership transition success. Start with identifying what the owner requires, from a financial standpoint, to enjoy financial independence. This will be unique to each owner yet will drive the decisions made toward developing their exit plan.
Next, identify whether a “gap” exists between financial resources, including the value of the company, and targeted financial need. An outside calculation of business value becomes essential to begin planning efforts and will indicate if value enhancement is necessary or if the owner could retire now. Not that most will, but affirming financial independence proves extremely empowering to owners’ psyches. It may no longer be the case that they “have” to keep pushing, rather that they “choose” to keep pushing. Big difference!
If value enhancing measures prove necessary to meet an owner’s retirement goals, multiple strategies exist. They will require time and investment. The next step is addressing the challenge of an internal buyer’s lack of capital or access to it. Devising a strategy that makes a purchase affordable while minimizing Uncle Sam’s mandatory share becomes essential. It can be done. It can be successful. Having a back-up plan in the event a triggering event causes ownership to change hands also is critical. The last thing most owners want is finding themselves in business with a deceased partner’s spouse, their offspring or legal representatives, particularly if they have little experience operating the company.
Lastly, even with the best laid plans, internal successor candidates may not share the owner’s enthusiasm for assuming ownership in the company. The only way to confirm their commitment and risk tolerance is to present, in writing, a workable plan and hope that they are on board. In the event they politely “pass,” then it may be time to pivot to Plan B. Open the flood gates. Go for maximum price, negotiate the best deal and ride off into the sunset. Because for well-run and well-positioned companies there exists unprecedented investment dollars waiting for deployment within the mergers and acquisitions marketplace. The market can be described as “frothy.”
