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What Does Your Succession Plan Look Like? (Part II)

What Does Your Succession Plan Look Like? (Part II)

By Bridget McCrea

In this series tED magazine explores the “new rules” of succession planning and outlines the key strategies that distributors should be using to prepare for the next generation of ownership now.

Mills Snell knows a thing or two about succession planning and about the ins and outs of owning an industrial distributorship that endures across multiple generations of ownership (family or otherwise). Unfortunately, this partner with Pendleton Street Business Advisors in Columbia, S.C., has more horror stories than happy outcomes to share.

“All too often, business owners hit ‘go’ on the first succession plan approach that they learn about, but not necessarily one that aligns best with their long-term needs,” says Snell, who know of at least one distributor that took part in a failed ESOP (employee stock ownership plan) buyout as its primary approach to succession planning. “Let’s just say, it didn’t end up going as planned.”

Is it Time to Sell?
In Part I of this article we detailed some of the key reasons for having a succession plan in the first place, but Snell says the driving force should go beyond a single owner’s need to at some point transition out of his or her business. For example, right now interest rates remain at historic lows and the lending environment is more favorable than it’s been in years. Combined, these two elements can boost a company’s chances of being sold (versus passed along to the next generation or liquidated).

“The cost of borrowing money to purchase a business is pretty affordable right now,” says Snell, “which, in theory, creates more margin in terms of how much someone would be willing to pay for a distributorship.” Snell says companies that have substantial balance sheets should take these points into consideration, particularly if much of the power and ownership is concentrated in one individual (a baby boomer who will soon be heading into retirement, for instance).

One area where small to midsized companies tend to go wrong in the succession planning arena lies in the assumption that a company is a “retirement ticket” or an “estate plan.” In reality, a distributorship is a thriving entity whose life could extend long beyond that of its founder, given the opportunity. And while second and third generations of family owners generally give the founders incentives to “keep things going,” Snell says other firms just close up shop when their owners pass away or retire.

“A lot of business owners think that if they work and save for a number of years that they can just push a button and retire, and that everything else will work itself out,” says Snell. “So, they give their notice, say goodbye to the company they worked at for 35 years, and then start their retirement.” With the exception of the high-paid executive who started saving when he or she was 18, this approach doesn’t usually work—and mainly because 80% of the typical business owner’s net worth is tied up in the company. “That’s not something you can just convert into cash within a few days,” says Snell.

The question is, what can owners and leaders of distributorships do to prepare for their own futures while also ensuring the longevity of their companies? The answer lies in good succession planning, which is defined as “any effort designed to ensure the continued effective performance of an organization, division, department, or work group by making provisions for the development, replacement, and strategic application of key people over time.”

Know How the Money Flows
Snell has seen numerous deals die on the negotiating table over the years, but says that the top reason these sales never close is due to companies’ failure to delineate between operating expenses and the owner’s discretionary cash flow. In other words, when assets are “co-mingled” (precisely what they tell you not to do when starting a business), it can really hurt you when it comes time to put your succession plan in action and sell your business.

“In every company there’s always someone in the ownership ranks whose personal expenses get lumped into the business’,” says Snell. “Sometimes it’s egregious and sometimes it’s not, but every business has vehicles, insurance, cell phones, and other expenses that start to mushroom.” The key, he adds, is to maintain a clear divide between what is and isn’t a legitimate business expense.

A Word of Warning on Management Buyouts
Snell cautions distributors to act cautiously when considering management buyouts, a process through which a company’s existing managers acquire a large part or all of the company from either the parent company or from the private owners.

While the approach may sound viable, and the idea of familiar people running your company extremely palatable, the manager who gets a taste of ownership may not want to go back to being an employee (and, he or she may not want to work for the new owners that you do decide to promote or work with).

“Before you open up these discussions,” Snell warns, “make sure the conversation materializes or consummates into a transaction. Ignore this warning and you could lose two things—the potential owner and your current employee—in the gamble.”

You may also wind up leaving some money on the table with a management buyout, says Snell, since an internal buyer will probably pay “substantially less” or require more financing flexibility than an outside acquirer. And speaking of outside acquisitions, Snell says it’s important to distinguish between the two different types, which are:  financial buyers (owners of private equity groups or investment banks that want to purchase your distributorship for financial reasons) and strategic buyers (a competitor outside of your area, for example, that wants to gain a foothold in your market).

“Financial buyers tend to pay a little bit more than strategic buyers,” Snell points out. “And those who pay the least are usually the internal buyers, mainly because they don’t have $5 million worth of assets to use to buy the business.”

Begin with the End in Mind
One way to ensure a smooth ownership transfer is by beginning with the end in mind—an age-old piece of business advice that definitely holds true in the succession planning field. In other words, instead of jumping at the first opportunity or throwing together a haphazard plan for the future, think about where you and your constituents, family, co-workers, etc., want to be in 10 years. Then, working backwards from that date, come up with a plan of action to meet that goal.

“Just because a colleague had a successful management buyout experience or transfer of ownership to the next generation doesn’t mean you will,” Snell points out. “Not every option will align with your own individual objectives.” By beginning with the end in mind, Snell says distributors can effectively reframe the transaction process (i.e, internal sale, external sale, liquidation, etc.), through a lens that truly meets those individual objectives. For example, if you waited until the last minute to do your succession plan and now you want to get out of the business as soon as humanly possible, says Snell, then you will probably have to sell at a steep discount (versus the owner who spent 10 years planning his or her eventual exit).

And finally, take it from someone who knows:  Understanding how much your company is really worth can save a tremendous amount of time, hassle, and frustration during the sale or transfer process. This knowledge can also help provide assurance for the retiring owner(s) who have much of their net worth tied up in the business.

“If your company has to sell for $6 million in order to fund your retirement, and if someone is offering $10 million, then you’ll be in a pretty good position (and even have some wiggle room),” says Snell. “However, if you need $15 million to maintain your standard of living, then $10 million won’t be enough. Understanding this from the outset really helps facilitate the whole process.”

SIDEBAR: SUCCESSION PLANNING Q & A — We dive even deeper into key strategies distributors should be using, in a Q&A with a succession planning expert.

McCrea is a Florida-based writer who covers business, industrial, and educational topics for a variety of magazines and journals. You can reach her at bridgetmc@earthlink.net or visit her website at www.expertghostwriter.net.

 

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