Of all the history-making accomplishments of the baby boomer generation, the single greatest is yet to be written – the biggest transfer of wealth in the history of mankind. According to the U.S. Census Bureau, boomers own 2.34 million small businesses in the U.S., employing more than 25 million people with an extended impact on about 100 million total individuals. The estimated value of assets within those businesses varies, but most hover in the $10 trillion range.
Even though roughly one-third of the population relies on the smart management of these businesses, 70% of which are expected to change hands as boomers step out of the workplace, another recent stat has economists and business advisers nervous. Wilmington Trust reported in a recent survey that nearly 60% of small business owners have failed to complete a succession plan and worse, many haven’t even given much thought to the sale or passing down of their companies.
Failing to Plan
This flies in the face of sound business planning said Anthony DeLuca, partner with Smith Pauley, who said failing to plan seriously jeopardizes the ability to exit a company in a way that serves the owners as well as the employees left behind.
“A succession plan should be viewed as a part of a business’s ongoing strategic planning and should be reviewed regularly,” he said. “Succession planning is unique in that it is an inherently forward-looking concept but is based, at least in part, on evaluating the past. In other words, where has the business been, where is it now, and where do we want it to go? As time goes on, all businesses change, and so too should their succession plans.
“It’s never too early to begin formulating a succession plan, and there is some truth to the old saying that ‘Failing to plan is planning to fail.’ Succession planning comes in many forms and is not a static event – it’s a complex process that requires strategic thought and careful implementation, often over a period of years.”
Rob Wellendorf, president of Execso Business Exit Planning, said he enjoys working with clients that have clear and achievable timelines.
“I like that sort of landing strip, looking out five to seven years,” he said. “If we have even two to three years that works, but anything shorter than that, I think the owner has what I call blurred vision.”
Fear of the Future
With so much at stake both at the individual company and global levels, it’s hard to imagine why business owners are so lax in their preparation for exiting their businesses. Some of the rationales offered by CNBC in a recent report include boomers’ reluctance to talk about exiting a business because it signals the end of their productive lives. In other cases, business owners lack the knowledge of succession planning to ensure they receive fair market value for their company, especially in these cash-strapped times. And some simply hide behind the demands of today to escape the uncertainty of tomorrow.
“I smile when I say you should start planning for your exit the day you start your business. Business owners shake their head and say, ‘I’m just trying to survive,’” Wellendorf said. “That normal business life cycle takes three, four, five years to feel like you really have a business, or you really have some success. But in those early years, I talk a lot about business continuity planning and just generally what that means is looking at any and every risk that might disrupt that business or the cash flow for that particular owner.”
Regardless of the source of the reluctance, the consequences all tend to lead to the same place – fewer options for when life and health take the decision-making process out of an owner’s hands and pushes it to the forefront, ready or not.
“Often, succession planning is not initiated until the imminent retirement of current ownership, resulting in a situation where the appropriate time to identify a purchaser or groom the next generation of owners within the company is no longer available,” said Scott Scheef, partner with HBE LLP. “Conversely, by starting early, business owners can determine who may be the right fit to purchase the company or, if the purchaser is among the current employee group, to address what we like to call the company’s bench strength.
“By reviewing the company’s bench strength, business owners can assess what pieces of the puzzle they have in place and what areas they may be weak in. Business owners can then take the necessary steps to retain the individuals that are key to the company’s continued success and recruit or train individuals in areas that may need additional attention.”
Studies are showing the situation is becoming more dire as the oncoming generation, Millennials, are proving to be reluctant to take over family firms and outside buyers aren’t as eager to buy right now, either. Refinitiv recently noted global merger and acquisition activity dropped 16% in the third quarter of 2019, the lowest in three years, suggesting many potential buyers are willing to just lay low, putting the squeeze on business owners looking to sell but who haven’t laid the plans to do so.
“One of the most common mistakes business owners make is overlooking the fact that succession planning is a tremendous way to build value in the business well before an actual transition takes place,” DeLuca said. “Another is viewing succession planning as a single transaction. Many businesses have a plan that is outdated or has remained rigid despite significant changes in circumstances surrounding the business and business owners.”
Start Simply, But Simply Start
Wellendorf said it is important for business owners and their professional advisors to understand there are two elements at work when starting a succession plan and without both being satisfied, little will get done. Therefore, he gauges his clients’ readiness both from a financial and an emotional perspective.
“The financial readiness of the owner seems the most obvious,” he said. “Rolling along and hopefully reviewing the value of the business every year, or sustaining the value of the business, financial readiness seems to be at the forefront of their minds.
“On the emotional readiness, I talk to the owner. Obviously, they have been running this business for many years, it’s given them routine, but also it’s giving them purpose, it’s giving them impact, they’re enjoying being challenged. I ask them, ‘Which of those will you miss and how can we continue to provide that at a time that you no longer own the business?’”
Once business owners overcome the mental and emotional hurdles that often hamstring succession planning, the most important initial questions to ask are the most basic.
“At a foundational level, the most important question to ask is what is the primary objective for the business owner?” DeLuca said. “Is it preserving or maximizing business value? Ensuring generational business longevity? Preserving family harmony in a family-owned business? Do tax objectives come above all else? There will certainly be multiple, sometimes competing objectives. However, it’s important to keep the foundational goal front and center.”
The process continues from this central goal as the plan starts to take shape. Again, it’s helpful to start with the fundamental questions and work into the more intricate details, Scheef said.
“When designing a succession plan, business owners need to ask themselves, ‘Who is our ideal purchaser and how can I best communicate our value proposition to decision-makers?” he said. “Whether the business is being sold to a family member, key employee or friendly competition, it is vital to know that the next generation of ownership is truly interested.
“Other big questions that business owners need to ask themselves include, ‘Do I have a business that others are willing to pay money to purchase?’ Then, if the answer is yes, is the sale price reasonable? For small business owners, the company is not only their livelihood but also like a child they have been responsible for raising. This passion for their business is admirable; however, business owners can benefit from taking a step back to make sure what they are creating is something that others would want to purchase.”
A Family Affair
A major complicating factor for business transition plans is the often-delicate matter of multiple family members involved with the business.
Wellendorf said a business owner should always take a team approach using outside help when forming a business exit strategy, including their lawyer, financial planner, accountant and business transition expert. But when the family is involved, it’s even more critical to have outside opinions and expertise that can see things from an unbiased perspective.
“In nearly all of my engagements, whether it’s family or nonfamily key people, I’ve got a resource who’s licensed in dispute resolution and mediation,” he said. “We will have confidential discussions with the next generation, both family members that are in the business and those that are not in the business, to help us triangulate how best to guide the owner or owners. We see that as not only important, but it is also essential.
“The other is making the unspoken spoken. I don’t want the patriarch or matriarch to be dead and gone and have any of the children or grandchildren say, ‘This is what Dad wanted or would have wanted.’ Hold on, we know exactly what he wanted because we memorialized it in the estate plan, and we talked about it in the semi-annual family meeting. So, once you get the plan designed and implemented, making the unspoken spoken is, in my opinion, the best opportunity to harmonize that business exit with the family dynamic.”