Preface: When you appreciate that all the factors that result in a higher business value will also result in a higher probability of a the continued success of the next generation of ownership, you have now realized the fundamental purpose of why your business is an investment.
Your Successor Looks at Your Business as an Investment (Segment II)
Credit: Donald J. Sauder, CPA |CVA
Commonly, many business owners think about a business transition, and how they will accomplish the next generation succession, and even retain an advisor to begin work on transition, e.g., developing the succession plan. Yet, that is only one step of many in a successful transition. One possible counter argument may be that the value of the business is not really that important to the seller, and only a cohesive working relationship with the successor owner is desired as shares transfer, hence the need for an advisor. While that reality may be true, (and this article is written towards the financial context of business transition) so is the fact that a business may transition for many reasons, e.g., owner retiring, relocating, pursuing new opportunities or interests, or generally looking for reduced responsibility with the existing business venture.
The point is, all the factors that result in a higher business value, will also result in a higher probability of a successful next generation of ownership. This includes, a stable and motivated management team, operating systems that improve and sustain cash flows, realistic growth strategies, diversified business risks and minimized revenue concentrations, growing earnings, and effective debt or working capital management. Is your business an investment? Yes, it is.
Small business organizations supply ownership with the cash flow and net earnings to provide for current and future personal and family expenses, gifts to the community (it is not an oxymoron that the synagogues are credited) and thirdly for most small family businesses, it often is the key reason they are most often financially secure, e.g., the successful management and investment of time, talent, and resources that accumulate and compound with the years. Note: unreasonable transaction values do create substantial financial pressures for buyers if the business transacts at a price substantially above fair market value, and cash flows shift in the business. While fair market value is subject to debate, realistic fair market value is not.
If you do not want to be a statistical failure with business succession, here is one advisor’s words of advice. “Consistently adhere to strong bedrock values and work towards a clear and united vision as a team. That is the best way to sustain a healthy (business) organization.”
A Keystone Business Transitions, LLC article written from the desk of Donald Feldman titled: The 7 Deadly Transition Sins, outlines the following awareness of business transition risks: abbreviated,
1) Failure to have a solid buy-sell agreement for multi-owner businesses. Businesses without such an agreement are playing Russian roulette.
2) Failure to have a business Continuity Agreement for sole-owner businesses. If the sole owner dies or becomes disabled, the business is at risk of dissipation. A well-crafted Continuity Agreement might empower your key employees to run the business and give them compensation incentives to do it successfully.
3) Failure to choose among children to manage the company. Sometimes children can work cooperatively as business owners, but parents are generally poor judges of this and it is advisable to bring in an outside expert to assess the situation.
4) Reluctance to relinquish control. This problem is sometimes most acute in family businesses when mom and dad are reluctant to hand over control to the children. The longer this reluctance persists (men are much worse offenders than women here), the more difficult the transition will be. As a rule, ownership transfers should begin no later than age 65.
5) Failure to think clearly about the tax consequences of ownership and management.
6) Failure to sell at the right time. Owning a business is an inherently risky enterprise. If you are at an age when you cannot afford to wait out a prolonged slump, you should sell while the market is good. The strong M&A market we have enjoyed for the last several years won’t last forever.
7)Failure to transfer ownership to the next management generation.
End of Segment II. To be continued.