We’ve all heard the adage there are only two things in life that are certain: death and taxes. While business owners are always cognizant of minimizing the latter, no one really likes to think much about the former.
As inconceivable as it may seem to someone in the height of their career, at some point, each and every owner of a private enterprise should come to terms with the fact that they and their business are, in fact, two separate entities, and at some point, the business will transition to different ownership.
Entrepreneurs are a special breed of people: driven, motivated, committed, passionate, tireless, invincible – the list goes on, and the prospect of separating oneself from what is often as intrinsically woven into the fabric of one’s being as one’s own child can seem daunting to say the least.
Many owners of private enterprises do bring in their children or other family members to the business with the ultimate intention of passing it on to them. But what if you don’t have kids? Or if family members have chosen alternate paths in life or simply aren’t cut out for managing and growing a business into the next generation?
What if your business is not the type of business that is a candidate to be sold to or amalgamated with another company in the same industry? What if there are no willing buyers knocking at your door ready to immediately offer you what you think your business is worth? Or what if you can’t possibly conceive of an outsider, who likely does not have anywhere near the same degree of commitment to and passion for your ‘baby,’ taking over what you have nurtured and grown for years? What will happen to your legacy?
It’s time to start thinking about that now, and a common scenario is an employee purchase or management buyout.
The first step is identifying whether you already have an employee who is a logical candidate or a team of managers interested in pursuing a buyout. Often these are people who have come up through the ranks, strong and capable, and who know the business inside and out. People who have a level of commitment to your business and a true and driven desire for it to succeed that is equal to or on par with yours. Those who share your vision and mission for the business and who you can truly see taking it over some day.
Other times, no such candidate(s) emerge. If this is the case, the recommended approach is to identify someone younger within your ranks who can be groomed to be this person, or to bring in someone from the outside to work in the business for a period of time to learn the ropes prior to your full exit.
Once an appropriate individual or management team has expressed interest, there are many considerations the seller must take into account. For instance, it is increasingly likely a purchasing employee or management team will not be able to procure financing to pay the entire purchase price up front. Scenarios such as bringing in employees as shareholders over time or vendor take-back financing are common.
Owners should be prepared not to expect to receive cash up front for the entire purchase price, but if they have a good business that is generating positive cash flow, they should feel confident they will eventually get paid in full. This is why it is crucial the seller choose the right person or group of people for the transition.
David Bentall of Next Step Advisors assists businesses across Western Canada with succession planning. He notes the importance of compatibility between sellers and buyers. “One of the few reasons that I may recommend partners do not work together is if they do not share the same values. For example, if one partner is a gambler at heart and the other is a saver then they probably should not be co-owning a business together. Similarly, if one partner is a proponent of environmental sustainability and another believes that money is the only measure of a business’s success, then they will likely not be good ‘bedfellows.’”
It is widely recommended sellers do bring in trusted advisers who can guide the entire transition process, ensuring the maximum value is received for the business.
One such adviser is a chartered business valuator (CBV). According to Doug Welsh, a CA and CBV who has been working with Calgary and area businesses for 30 years, an independent business valuation is what sets the stage for successful succession planning.
Though there are as many different approaches to valuing a business as there are valuation methodologies, financial metrics are of course always crucial. Assets, liabilities, an analysis of the financial statements and projected future earnings and cash flows dictate what a business is worth.
In addition to the hard metrics, though, a business valuation must also take into account its intangibles. Aspects such as determining the level of risk associated with dependencies on key customers or suppliers and – particularly with owner-operated private enterprises – the human resources of the business are considered too.
Often, much of the worth of a private enterprise is dependent on its founder. Goodwill, industry knowledge and experience, and a deep and fundamental understanding of all aspects of the business tend to be inherently linked to the individual who started it. As such, these can be lost if selling to someone who does not have this level of connection.
If these unique skills have not been transferred to others, it is reflected in the value of the business. This underpins the need to identify a purchaser well in advance of the expected date of transition. Welsh points out it can often take five or 10 years from the time of identifying a suitable employee who is interested in purchasing the business to when the transition is actually completed.
Because it can be such a long process, it is important to retain not only a valuator, but actually a whole team of advisers early on. Choosing the people carefully cannot be understated. “Start setting up an advisory group many years prior to the anticipated transition” Welsh says. “Have different skill sets – everyone should bring something special to the table.”
From one’s own CFO internal accountant to external accountants, lawyers and even negotiators, the appropriate advisory board will depend on the business being sold, but in all cases advisers work together to ensure the seller receives maximum value for the business.
Dave Zimmel is a partner at MNP LLP and vice president of private enterprise. He provides assurance, accounting and advisory services to clients in a range of industries. Zimmel agrees that involving advisers early on is wise and can maximize value down the line. “Having an experienced tax adviser on your team from the very beginning can ensure that tax opportunities upon transition are maximized to the fullest extent possible,” he says. “Depending upon the nature of the business, careful restructuring over a number of years may allow for significant tax advantages to the owner when the business is sold.”
There are many considerations when transitioning one’s business to an employee or group of managers. Starting the process early means what is important to you can be achieved and you can indeed be set up well for the next chapter of your life. Tax advantages, a smooth and painless transition period, adequately funding retirement or your next project, leaving a legacy – all are likely outcomes when succession planning is started many years in advance of the business owner’s anticipated exit.