Succession Planning

By Generational Equity

04/16/2012

One of the fundamental issues with many privately held businesses is the fact that they are completely dependent on their owners for success far too often. Let’s face it – most entrepreneurs are geniuses at what they do. In fact, if you are the owner of a business that is still in operation today, having survived the worst recession in 80-plus years, you deserve a huge pat on the back. Being in business today requires nerves of steel and a stomach of iron.

Having said that, the truth is that one day you will eventually exit your company. When you get to that point, if your business is totally dependent on you for its ongoing success, you will have a challenge finding buyers who will pay you a premium for your company.

This concept was demonstrated a few months ago when a lower middle-market equity firm, Milestone Partners, announced it was raising its fourth fund in order to invest in smaller companies. For their third fund they raised $240 million dollars in 2008 and, according to their portfolio page, invested in nine companies. But what caught my eye on their website was this comment found in the investment criteria section:

“We will invest only when proven management teams with demonstrated records of success are part of the opportunity.”

Notice that this statement is plural. They look for management teamS. I capitalize the “s” to emphasize a point every small business owner needs to realize: If you aren’t developing and grooming a cadre of managers to eventually replace you, you better start soon.

Professional buyers look for companies that are diverse in their dependence on key people. Businesses that rely on their owners simply do not command a premium in the market. And, in fact, what you will often find is that most of the dollars in the deal will be in the form of an earn-out.

Succession Planning and Deal Structure

For those of you unfamiliar with the term, an earn-out is a deal structured where a portion (sometimes a significant portion) of the purchase price is contingent on future performance. It is typically payable to sellers only when certain pre-defined levels of sales and/or income are achieved post acquisition.

If your company is dependent on you, a buyer may require you to stay on board to help the business reach the revenue and profitability goals that you provided in your offering memorandum. If you don’t achieve them, you get paid less. And you will still be working hard, maybe harder, than you are now. Is that what you want after you sell your company? Most folks would say no, that they want to move on after they sell.

The only way to realistically move on is to develop a middle-management team. Here is an exercise we encourage many business owners to do: Sit down and list your key employees. Describe why they are vital and discuss the skills that make them so. Also list their weaknesses and what they need to improve on.

If you have trouble filling out this list, chances are good that you haven’t developed a good set of middle managers to replace you. Again, if this is the case, you need to start developing a team today that can keep the business growing upon your departure.

Professionals Are Available to Help You

Successful succession planning is a real challenge for many entrepreneurs. But it is vital. Fortunately, Generational Equity is here to help. We have been working with business owners for years to successfully exit their companies.

The first step in our proven process is to conduct a thorough evaluation of your company. One of the key areas we examine is your succession plan. If you don’t have one, we will give you some ideas on why you need to create one and how a lack of one might impact the sale of your company.

Bottom Line About Succession Planning

If you are planning to eventually exit your company, you need to develop a well-thought-out and documented succession plan. To start, you need to hire and groom successful people who can replace you. These people should form the backbone of your company, giving potential buyers a comfort level that the business will succeed when you are gone.

Don’t let your ego get in the way. You are most likely a great business owner and a genius at what you do. But you will need well-groomed middle managers if you want to find an optimal buyer who will pay a premium for your company.

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