The COVID-19 pandemic that’s swept the nation adds a new issue for business succession and transition planning.
The crisis has caused wild swings on Wall Street that have affected investment portfolios, pushed the economy into an expected sharp decline for at least the second quarter, and generated uncertainty about what the future holds.
That all may lead some owners to reconsider an impending exit and sale of their business, said Chris Matthysse, an attorney in the Grand Rapids office of Mika Meyers PLC who works with business owners on succession and transition planning.
Just as with the 2008 financial crisis that affected and delayed exits by business owners, the COVID-19 crisis could prompt some people to wait to retire until well after the crisis passes so they can have a better picture of what the future holds. That’s particularly true if the predicted economic downturn brings down multiples, reducing how much an owner can get from the sale of a business.
“There is so much uncertainty out there right now it’s going to cause delays in exits,” Matthysse said. “When we have uncertainty, people like to cling to things they’re certain about, and a lot of time that is the business.”
The crisis may affect deal flow among buyers in the market, particularly if financing becomes harder to obtain, Matthysse said.
That scenario could play out in private equity.
The amount of dry powder, or what private equity firms have available to invest, sits at record levels. Firms will continue to deploy the capital, “albeit more slowly and perhaps more prudently than in the last few years,” according to a Pitchbook report this month that examined the effects of the crisis on both private equity and venture capital.
Yet the present crisis will someday pass, and owners still need to plan for the eventual transition and succession of their companies to new leadership.
Professionals say that the planning process needs to begin years in advance. A well-planned transition is more likely to go smoothly, enabling an owner to find the right buyer that’s a good fit for the business, and improving the chances of achieving the desired financial results from a transaction.
“Rather than doing it just in the last few months or the last year before they want to retire, really starting several years ahead and having that longer vision for it, that’s a big thing,” said Doug Bajor, a senior wealth management adviser at Greenleaf Trust in Kalamazoo. “If you can start putting the pieces in place three, five, seven years ahead of time, the value you can create for the business when you ultimately want to step aside can be that much better.”
Assembling a team
Owners can begin the planning process by first deciding when they want to depart, either through an outright sale or transitioning to new leadership to run the company after they retire. They also need to consider what they want out of a transaction and what they need financially to live on in retirement.
A sale could include retaining a minority stake in the company with continued involvement, perhaps in a compensated advisory role.
As owners plan, they should retain a team of legal, financial and tax advisers to help steer them through the process, experts say. When the time comes to put the business on the market, one of the first steps is to have a valuation done on the company so they can set an asking price.
In family-owned businesses, leaders should have the conversation with the next generation years in advance to see if a child wants to take over the business at some point. Don’t presume they do, professionals say. If the next generation expresses interest, get them involved in the business early and groom them to move through the ranks so they’re ultimately prepared to lead the company.
A good plan also should consider unforeseen circumstances and prepare the business for the sudden departure of an owner or leader, such as when a sudden illness leaves an executive unable to work or in the case of a death.
“If you’re gone, who’s going to run it? Do you have somebody in the business that understands it? Because if you don’t have somebody that understands it, the business — no matter what it’s value — is as good as gone,” Matthysse said. “You need to have somebody to keep it going in the transition time period.
“If it’s the next generation, what do you need to do to get it down to that next generation? Most (business owners) have not thought about that until the question is really posed to them. I think they’re too busy running the business to think about who’s going to run the business if they’re not.”
Owners also should identify executives that someday could rise to lead the business, or who may want to buy the company.
Once an owner knows when they want to depart in the future, they can smooth the transition by turning over responsibilities and day-to-day duties to up-and-coming leaders as a way to prepare them for the future.
Having the next generation ready to take over helps when negotiating a sale and ensures a prospective buyer that the company they are acquiring has leadership that’s well prepared, said Jeff Williams, the managing principal at Grand Wealth Management LLC in Grand Rapids who works with businesses on succession and transition planning.
“That’s really going to help them get their price for the business. It’s going to prepare the business to succeed without them,” Williams said. “It’s going to better protect the employees the owners care so much about, and it’s going to prepare them, too, for backing away or walking away from the business.”
An owner planning the company’s transition needs to take into account what they’ll do next in life, and prepare managers and employees for the transition, as well as communicate their plans well in advance.
If a business is prepared for a transition, owners are better able to secure a buyer who fits culturally, who will retain staff, and who will stay involved in the community.
“Some owners are going to say, ‘I just want to maximize the sale of this and move on with my life,’ and then you have other owners who are more tied into who is working for them,” Matthysse said. “A definite consideration for owners is: What happens to my employees? That’s a very difficult question. These employees are family.”
One increasingly popular option business owners are considering is forming an employee stock ownership plan, or ESOP.
Brian DeMaagd, managing director of Vision ESOP Valuation LLC in Grand Rapids, has seen interest in ESOPs grow in recent years.
“Definitely, from a mid-market standpoint, there’s a lot of activity. For smaller businesses as well, there’s good opportunities,” DeMaagd said.
A company should have at least 20 to 30 employees and a minimum of $1 million to $2 million in EBITDA “before it makes a lot of sense” from a cost perspective to do an ESOP, DeMaagd said.
In the middle market, Vision ESOP Valuation’s average client typically has $50 million in sales, $5 million in EBITDA and about 100 employees, he said.
In an ESOP, which is managed by a trustee, companies transfer shares to employees over a period of years. That typically comes through an annual distribution of shares.
Owners seeking a transition or exit can take their money out of the business through standard bank debt that the company takes out to fund part of the transaction. Many ESOPs today also are funded through seller’s debt. As the company pays off the debt, the owner’s shares are released, DeMaagd said.
ESOPs have gained particular interest from owners who are concerned about their legacy after they exit or retire, according to DeMaagd. ESOPs generally do not involve a name change and can retain the culture within a company that the owner built and nurtured for years.
In West Michigan, legacy is a “huge” consideration “and one of the primary factors why owners take the ESOP route” when preparing for their eventual departure, DeMaagd said.
“If legacy is important to the owner, ESOPs are a really good fit,” he said. “It’s a good alternative to private equity or a sale to a competitor, or a strategic-type sale, because of that.
“That’s why in West Michigan there’s a high concentration of ESOPs. A lot of the reasons are that culture, the kind of family, close-knit organizations where owners really want to reward the employees or give the employees more opportunity to share in the value increases.”