Family businesses range from small start-ups to $500 million organisations. And with half of business owners expecting proceeds of sale to fund their retirement, succession planning is becoming an increasingly important issue. Below are some exit options for business owners.
Around 80 percent of Australian businesses are privately-owned, with a total value of $3.6 trillion. About 40 percent of business owners are planning to leave their business in the next five years. $1.6 trillion worth of family businesses will change hands as baby boomers retire over the next 10 years.
With half of businesses owners expecting the proceeds from the sale to be the primary funding source for their retirement, succession planning is fast becoming a major issue.
Ways to exit
The alternative ways to exit are:
1. Succession of Ownership (to children or other family members).
2. Succession of Ownership (partial or total management buyout or ‘MBO’).
3. Capital raising (for those businesses large enough to withstand the cost and due diligence process).
4. Merge with others.
5. Sell as a going concern.
6. Close and liquidate assets.
Appeal of different exit strategies
This is how business owners say they would like to exit:
• Sell to a third party: 60 percent
• Family Succession: 30 percent
• Sell to management or staff: 10 percent
It takes careful planning and thought to achieve a graceful exit from your business, especially to someone you know. The succession plan outlines how the critical roles in the business will be filled. First, you need to know where your business is now, and where you would think it will be in the future.
The succession plan should deal with two main components: ownership succession or transfer of assets (transferring the wealth in the business to the designated successors) and management succession/transfer of power (management and control is transferred to the successor). This is appropriate when the owners want to retain ownership but reduce or relinquish their role in its management.
In the sale to a third party, both are transferred together.
Because the proceeds from sale are likely to be an important part of owners’ retirement funds, they cannot afford to give away their businesses to their children. Whether or not the owner is transferring the business to family members, they usually want the value they deserve out of the business. A professional valuation is needed even if selling to family members. Your accountant can usually arrange this.
Where the owner chooses to take no further part in the business, and transfers both ownership and control to his or her family, there are a number of considerations:
- Seek outside professional help to navigate through the emotion that surrounds the process. An objective adviser can help resolve disputes and ensure that the decisions made are the best for both the family and the business.
- Hold a family retreat; a structured meeting with one or more generations.
- Write a constitution, prepared by your lawyer that covers a wide range of matters.
- Build in flexibility. The plan needs to be flexible enough to be changed if circumstances change.
- Family: The owner may want leave the business to the children but in most cases the children don’t work well together and arguments damage the business.
- Consider the structure. Select an appropriate legal structure.
It is important to provide for the ongoing, capable management of the business. Multiple classes of shares and shareholder agreements can be used to match the specific objectives of family members with their ownership rights.
Some specific techniques which can be employed include:
- Separate ownership from management interests: Different classes of shares can be issued to children not in the business which entitle them to dividends but not voting rights.
- Direct or restrict subsequent share transactions: Include provision to deal with a family members’ desire to sell their shares. Mandatory buyout of the shareholders’ interests, either through redemption or requirement to sell the shares, is a standard approach to handling this type of situation.
If a business owner wants to retire, but does not want to relinquish ownership of the business, he or she might appoint a family member, partner or manager to run the business. This has the advantage of continued involvement without the responsibility of dealing with the day-to-day running the business.
The options available in terms of selecting a manager for the business include a family member, key employee, committee of family members or an imported manager.
- Letting go. The owner must accept that he or she no longer controls the business. Handing over can be the most difficult decision that an individual has to make in their professional life. Many owners find it difficult to step back from a business and leave decisions to others. If they fail to step back, then they are not really retiring and the intending manager may become dissatisfied and frustrated.
- Expectations and capabilities of senior management.
- Have a clear timetable for succession.
- Start early. Succession plans take time to develop and implement. The replacement manager should be progressively trained and assume responsibility as they prove themselves.
- Qualification and abilities of family members. The successor needs to qualify with appropriate experience. Assess whether family members have the aptitude and interest in running the company. Many parents find it difficult to properly assess their children’s management capabilities. A professional appraisal should benefit both the children and the parents.
- If more than one family member wants to take over, consider how the family members will work together.
- Set up a Board of Directors of non-family members. The business should be strengthened and many family arguments may be avoided.
- Continuing liability. If the owner continues as a partner or director he or she may become personally liable for debts incurred by the business, even if he or she had no knowledge of the debts.
Family succession in perspective
Only a small number of family businesses are actually transferred to family members:
• 70 percent are either sold or closed
• 30 percent are passed on to the second generation; and only
• 10 percent make the third generation.
These low succession results point to the need for those who want to transfer to family members to plan early. About 40 percent of owners have children they believe are capable of taking over the business but only 20 percent believe their children are both willing and able to take the business over.
Succession to staff or partners
Succession can also mean the sale of the business to loyal employees or to others who have worked with the owner for many years. Appointing a manager allows the owner to retire without transferring ownership. It can be a useful interim step, provided safeguards are in place. Having a stable manager will usually make it easier to sell the business at a later stage. Where the owner has relinquished management but not ownership and later decides to sell, he or she may not receive the same price as while still personally involved.
Conversely, some businesses thrive under new management and significantly increase in value. Either way, there is additional risk that needs to be taken into account.
Management Buyout (MBO)
A Management Buyout is the purchase of a business by its management, usually in conjunction with an outside financier. Private equity MBO financing is where a business is purchased by its management team with the assistance of a private equity fund.
Buyouts vary in size, scope and complexity. The key feature is that the manager acquires an equity interest in the business for a relatively modest personal investment. The existing owner normally sells most or all of their investment to the manager and the financiers as co-investors. This may be an option where the business has a management structure that can carry on the business without the owner and the MBO team has the financial capacity to structure the MBO funding. Management Buyouts have a good success rate and can typically achieve significant returns for the owner/vendor.
Management Buy-Ins (MBIs)
Management Buy-Ins occur when an external management team, usually in conjunction with outside financiers, purchases a business they do not currently run. MBI teams can provide the key to unlocking a transaction for a vendor. Sometimes owners are keen to sell their businesses but don’t have the management teams willing or able to take the business forward.
The investment horizon for a private equity investor is usually between three-to-five years. Exits are normally achieved by listing on the stock exchange through an initial public offering (IPO) or by the sale of the business.
Part-sale to a passive equity partner
There is plenty of money available for investment in good businesses. What is in short supply are people capable of running them.
The equity partner will be comforted by having the owner stay on to run the business. This may suit owners who want to unlock some of the capital invested in the business whilst maintaining an interest and an ongoing income stream.
Both parties must have an exit strategy. This may be by way of ultimate sale to a third party or the equity partner installing a manager before the owner retires. An equity partnership may also be appropriate when some of the partners in a business are retiring and others want to stay on but can’t afford to buy the exiting partners’ shares.
Part-sale to an active equity partner
This involves the new partner assuming responsibility for the operation, with the original owner retaining a financial stake and involvement in the operation for a period of time, coinciding with the retention of part equity. There needs to be a phase out over an agreed period.
This may suit where:
• The owner wants to ‘pre-sell’ the business in preparation for ultimate retirement.
• The owner wants to maintain an interest in the future success of the business.
• The incoming owner wants this additional security on handover to ensure a smooth transfer of the goodwill of the business.
Merger with a similar business
A merger is when two companies agree to go forward as a single operation rather than as separate entities. By merging, the combination of the two should create a more competitive, cost-efficient operation than either one currently is. The two companies should hold a bigger market share and achieve greater efficiencies through such a deal. A merger may also benefit organisations unable to survive independently.
Mergers may be driven by the need to create an organisation large enough to support a stronger management team than the separate organisations can justify. This may allow the respective owners to retire from the operation and achieve management succession.
This is by far the most common way for owners to exit their business. With baby boomers now retiring from their businesses, and with their children off doing other things in most cases, their only real exit strategy is to sell.
After the business is sold, the owner no longer needs to worry about it and this can be a great relief in retirement. This strategy provides for the sale to the broader market of prospective purchasers.
The sale may be the single most important business transaction for the owner. It is essential to plan early, get the best possible advice and then proceed to the market with a clear understanding of how much you are likely to realise from the sale after tax.
Key rules when proposing a sale:
- Make sure the business is ‘sale ready’.
- Obtain a business valuation.
- Have an Information Memorandum professionally prepared.
- Make sure the business is properly marketed.
- Don’t try to negotiate the sale yourself.
–Tony Brown is director of Supertrac (www.supertrac.com), a corporate advisory firm specialising in business divestments, mergers and acquisitions to medium and large organisations.