By Dave Raden and Cameron Bishop for Capitus Group
Let’s discus how to examine all potential options to meet your Personal Goals!
In a recent article, I discussed the importance of utilizing a formal transition process and provided an overview of a 4-Step Transition Plan for your business:
- Options Assessment
- Strategy Selection
- Plan Execution.
On the topic of Discovery, I broke Step 1 into two components. The first article which addressed part of Step 1 covered Discovery-Personal Transition Preparation/Goal Setting with the second article covering Step 1 addressed Discovery-An Objective Evaluation of Your Company. Part 2 focused on understanding where the company stands in its lifecycle today and what its value and risk parameters really are.
However, many times in the Discovery process, there is a significant gap between ownership’s goals and the current state of the company. It is at this juncture that more in-depth analysis on both sides of the equation must occur. This is essential to best determine and evaluate all potential options.
Assuming the delineation of ownership goals in Step 1, there may a need to conduct more in-depth financial planning, investment evaluation and work on the personal or non-financial goals. For example, defining the role of family members in the business or even life after a transition.
With regard to the company, there may need to be a valuation performed as well. Plus, a more detailed analysis covering what will be needed financially for the company to meet ownership goals and how that number can significantly affect non-financial ownership goals.
In Dave’s own case, he had a big disconnect between company and personal goals. For his business to grow, he needed to take on substantial corporate debt which would have totaled almost 8 figures over 3-5 years. The capital was needed to buy critical equipment. But, that didn’t mesh well at all with his declining personal risk tolerance.
Both personal goals and corporate discovery issues must be understood to move forward.
Step 2-Options Assessment
The output of Step 2 is a comprehensive list of realistic options to achieve ownership’s personal and financial goals. This assessment includes the pros and cons of each option.
We at Capitus Group have found that the best way to identify all potential options involves assembling a team of specialists that is led by a Corporate Transition Specialist. This individual works to not only recruit the team but to manage the team and to keep focused on ownership goals.
It is also important to note that the Transition Specialist should not have any conflicts of interest. It is imperative that all options are evaluated in a fair and balanced manner. The advisory team might consist of the company’s accountant/CPA or CFO, business attorney, insurance broker, benefits provider, personal investment or wealth management advisor, personal trust attorney and any other pertinent resource or expert.
This team may also include an appropriate management representative. While this team is usually separate from an Advisory Board or Board of Directors if the company has one, either should be considered another valuable resource and sounding board.
The Option Assessment Process
At this point after Discovery, ownership goals may fit into specific categories as exampled below:
- After tax financial goals
- Continuing personal business involvement
- “Life after”
- Family involvement in transition
- Risk delineation
- Desire to reward associates
- Effect on associates
- Desire to leave a “Legacy”Potential Transaction/Exit Strategies might include:
- Intergenerational transfer
- Internal management buy-out using external financing
- Internal management earn-in over an extended period of time with limited external financing
- External management earn-in over an extended period of time with limited external financing
- External sale/merger
- Strategic buyer
- Financial buyerIn order to properly evaluate the potential of the above strategies, the Transition Team must apply the ownership goals from Step 1 to each option to determine which match the best. Issues below are not a complete list but are some beginning items for the team to discuss:
- Intergenerational Transfer
- Are family members capable and willing to run the company? When?
- If multiple family members, who will be in charge?
- Family dispute resolution process
- Governance transfer process/timeframe/effect on associates
- Financing of the transfer
- Owner carry
- Ongoing owner guarantees
- Internal Management Buy-Out (MBO)
- Management capability
- How will the management team finance the acquisition?
- Team governance issues
- Owner carryback? Timeframe?
- Internal Management Earn-in
- Is the right person(s) with the skill set and proper cultural style in the company today?
- Will the person have some of their own skin-in-the-game from the beginning?
- Does the timeframe of buy-in agree with owner goals?
- What is the structure that allows for the company to help the buy-in process
- Governance and control issues
- Failure risk
- External Management Earn-In: This strategy has all of the issues from Section 3 except that the person(s) buying-in usually have not been vetted by the owner to the same extent as someone who has been with the company possibly for many years.
- Is the proper management in place for a successful ESOP?
- What amount of stock needs to be sold to the ESOP to meet owner financial goals?
- Is the external valuation high enough to meet ownership goals?
- Does the debt needed to fund the transaction hamstring the company’s ability to grow enough to de-lever once the business has been heavily leverage to fund the buy-out?
- Ongoing risk
- Potential limits on future sale/exit options
- External Sale/Merger
- Does the after-tax net gain meet financial expectations relative to ownership goals and financial needs?
- Need to engage good transaction advisor
- Strategic Sale- usually yields better financial results
- Financial Sale-the buyer in this instance doesn’t have a strategic reason for the acquisition so without strategic opportunities or economies of scale, the price is usually lower.
- Is the management team capable and willing to support and run the business post transaction event?
- Asset vs stock sale issues
- Continuing involvement: Is ownership willing to continue in a consulting role for a period of time after the business is sold?
- Carryback: Is ownership willing to finance any part of the purchase price by carrying back some level of debt?
Once each of these strategies is evaluated against ownership goals, it may be necessary to spend time to prepare personally as wells as a corporately to maximize the final outcome. Often, we find that either the owners or the company, if not both, may not be ready at the time of evaluation for a successful transition to take place.
It is also important to understand that the work and preparation necessary to optimize value can often take several years or more. Some examples of essential preparation include:
- Training the younger generation to be able to effectively run the company on their own
- If the company’s current value won’t meet owner expectations, a formal plan should be developed to increase corporate value while reducing corporate risk.
- Hire a second-in-command who can take over in the future to allow for multiple transition options-i.e. external sale, MBO or even to assist an intergenerational transfer.
Peter Heydenrych of Corporate Finance Associates states: “Nothing enhances a buyer’s perception of value more than evidence of sustainable growth and a capable management team as the key to managing the risk.”
- Evaluate changing the corporate legal structure for tax efficiency
- Restructure corporate debt/equity structures
These are just a few tactics that, if applied early enough, can significantly enhance the probability of meeting or even exceeding ownership goals.
In summary, utilizing an interdisciplinary team of experts to aid ownership in exploring all possible options to meet expectations is an essential element in achieving transition success.
It is very easy to become inertia bound and not adequately explore all options and each option’s impact on all stakeholders. Thorough planning is difficult, time-consuming and sometimes painful work. So much so that a 2015 poll by Harris Williams & Co. found that only 25.1% of respondents looking at a business transition indicated that they had a detailed transition plan in place.
In our next article, we will explore Step 3- Strategy Selection. We will address the best way to use the transition team in tandem with ownership and management input. The goal is to identify the right transition strategy along with an understanding of what tactics will need to be employed to optimize value and deliver a successful exit or transition.
Dave Raden and Cameron Bishop are partners with The Capitus Group. The firm provides comprehensive business value enhancement and transition strategy solutions. Partners and Advisory Directors comprise an experienced team of business professionals who have successfully owned, run, grown and sold companies. Capitus utilizes proven value enhancement and risk reduction techniques to enable superior transition options.
Copyright Capitus Group 2015