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Succession Planning

The Off Ramp

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MCN Editor Dan Markham COVID and its aftermath have left many business owners across all industries looking at moving on from the companies they’ve built.

One of the major developments coming out of the pandemic was the dramatic exodus from the workforce for so many Americans. The Great Resignation, the phenomenon has been called. 

The phrase has been generally understood to cover all of those working in subordinate positions, both salaried and hourly. But many observers note the wholesale departures are also taking place at the ownership level.

“The Great Resignation is real,” says Michael Zahrt, an attorney with Foster, Swift, Collins & Smith PC, Grand Rapids, Mich. “You had a lot of people home who thought [the business] was their life and it gave them a lot of fulfillment and they realized they want to be home with their families.”

The Bureau of Labor Statistics reported that an average of 3.9 million people per month left jobs in 2021, a significant number of them Baby Boomers, notes Angie Henson, principal, Valesco Industries, Dallas. “That same demographic includes many small business owners, suggesting that many are considering exit plans.”

Handing over the business a service center owner built or maintained has long been a difficult task. The past 24 months, however, may have made the prospect a little easier. 

First- and second-generation owners of service center companies, and others in the industrial space, have spent the past two years navigating one of the more challenging periods of their lives. 
While 2021 was a profitable year for most operators given the rising price environment, the conditions they were operating under still made for many sleepless nights. 

Thus, distribution business owners are more likely than ever to be looking to relinquish control of that business they’ve guided for decades.

“Across industries, we’re seeing a number of business owners, first- and second-generation family founders where previous conversations said, ‘I’m having too much fun. I’m going to die at my desk,’” recalls Brian Andreosky, senior business advisor for Aldrich Capital Advisors LP, Lake Oswego, Ore. 

That was before the pandemic. Now?

“Those conversations quickly changed, whether it was someone in the ag or manufacturing/distribution or construction industries. I don’t think that’s really in the cards anymore, and they’re asking what they have to do to plan to transition to new ownership,” he says.

The reasons are multiple. First, operators had to steer through the pandemic, keeping the business open and employees safe while a deadly virus raged around them. That was followed, for many, by mandates that had to be observed, the degree to which they were implemented varying wildly by location. 

At the same time, the industry was facing rising prices and declining supply, forcing operators to scramble to keep metal on the shelves for their best customers. And that had to be done when finding and retaining reliable employees was harder than ever. 

It’s no wonder more and more think this might be the time to step aside. 

Alas, there’s one problem with the plan. If you think today is the ideal moment to turn over the business, whether that’s to the next generation in the family or to an outside buyer, the best time to plan for this occurrence was several years earlier, experts say. 

Good succession planning can take anywhere from a year, at a minimum, to a decade. All participants agree the more time you take between when you begin seriously planning and the moment ownership changes hands, the smoother and more profitable that transition will be. 

“The rule of thumb is three-plus years,” says Ben English, a partner with Hirschler Law, Richmond, Va. “There is a lot that goes into the sale process, and you need to take a step back to do a brutally honest assessment of the business.”

The rule exists whether an obvious replacement, such as the next generation of the family, is in line to take over, or if the current ownership group plans a clean break with a sale to an outside entity. Both exist with the idea the enterprise carries on. 

“If your business is successful, it will likely outlive you. A good business plan views the company in perpetuity,” says Henson. 

“The succession plans that are most successful are the ones where people are always doing succession planning,” Zahrt says. “It’s one of the priorities of the business. They have their growth goals and their succession goals. It’s productive paranoia.”

That paranoia is founded in five Ds – death, divorce, disability, disagreement and distress –any one of which can result in the need for the current ownership group to depart the business.
In many ways, an ongoing succession plan is similar to insurance, protecting against catastrophe. But the more likely scenario is a gradual, natural departure, where it’s still beneficial to plan ahead. 

Owners may want to plan for the time in the distance when they’ll be looking to make a break, and then work backward to achieve that end. Doing so requires the careful examination of all aspects of the business English mentioned. And it can involve some things that seem to be obvious, but often aren’t, such as understanding just who comprises your customers. 

Jules Brenner, founder of the Los Angeles-based manufacturing succession company MSP, says it’s surprising how many companies in the industrial space don’t really understand their customers’ businesses. “I don’t know how many times I come across business owners in the space who don’t know a) why customers buy from them instead of someone else, and b) what industry segments they’re predominantly in.” He says it’s good for business owners to answer those questions before trying to entice someone else to take over the company.

For sales, another key piece of the puzzle, is getting financials in order. “We see a lot of businesses that don’t have audited books, especially more job-shop-revenue companies. It’s really hard to get a loan approved for that,” Brenner says. 

English agrees a strong, easily understood financial position is critical. “Most private companies, they know what they’re doing and they know their systems very well, but when they sit down and try to explain it to a buyer, there are going to be question marks. And the financial statements are the No. 1 area where, if there are some unknowns, it’s going to increase the buyer’s perspective of risk, which is going to have the opposite effect on price.”

At any case, anyone looking to sell should speak to professionals such as lawyers, brokers or other financial planners. Oftentimes, they’ll be looking to make a deal with private equity companies or other larger entities, firms that will enter negotiations with much stronger  backgrounds in these types of deals. “A family owner may be dealing with a level of financial analysis and sophistication he or she may not have seen in his or her business. What they’ve done has served them pretty well, but they’re about to play a different game with different players, and they need to be ready for that,” English says. 

Of course, another common option for business owners is to transition control over to the next generation, a child or other family member or even a management acquisition by an existing employee or employees. Such a scenario doesn’t necessarily make the exchange easier.

Again, starting early is of paramount importance. The first step is understanding whether the next generation is really interested in running the company.

Once that’s established, those future leaders should be brought up to speed on multiple aspects of the business. Throwing them in all at once is not a sound practice for continuity, even if that’s how many second-generation owners were forced to take the reins. 

“Get your next generation involved in management activities first, to make sure they have the chops for it,” says Zahrt. “Often when I meet with someone and they say their son is going to run the business, they don’t know how to read an income statement and they’re not meeting with the CPA to talk about how to mitigate their tax liability. You don’t have to give them full authority right away, but there’s a big difference between rank and file and management.”

“We often find situations where the current owner controls all the key relationships. She knows the banker and the supplier contacts and that sort of thing. I would encourage those people to make themselves as irrelevant as possible and start to transition those relationships to other people who are going to carry the business forward,” English says.
In some cases, the son or daughter may be adept at certain areas of the business, such as marketing, but need assistance on operations. Some may be able to work their way into a position of competence over time, while in other cases other internal, or external, options must be pursued to complement the next generation’s strengths. That’s not uncommon.

“To replace an entrepreneur owner/executive, it often takes a couple of people to carry the position forward,” says Henson. “Important questions must be answered. Is the candidate viewed as the standard bearer of the company brand? Do they exemplify the culture? Are they or will they be viewed as the right person by customers, team members, suppliers – the company’s community?”

Outright selling or next-generation ownership aren’t the only possibilities. “There are more solutions than there were 10 years ago,” says Andreosky, citing the possibility for minority partners or corporate sponsors among them. “I really think it’s just getting people to think about their options and what are the attributes of each solution and which check the most boxes for what you’re interested in.”

Regardless of who is taking over the business, the owner must understand what he wants from his exit. Though some may have already squirreled away enough for retirement, others are going to want to cash out even if the business is staying in the family.

For those selling, the proposition is somewhat easier, as maximizing the return is typically the primary concern. But even still, owners must understand some realities. “You let us know a fair market purchase price that meets your goals and we’ll find you a path to get there with creative terms,” Brenner says. 

Even family ownership transitions may involve a sale, with the existing owner often taking on a promissory note in the process. “Maybe it’s a discounted sale, but it’s way more advantageous for the second generation to buy out mom and dad on a note and get bank financing. Mom and dad don’t want a lump sum,” Zahrt says. 

Any kind of sale to a predetermined buyer, such as existing family or a small management group within the company, will be made with some cross purposes involved. The owner will be looking to maximize his return while still preserving the business for the family or a loyal group of employees. Also, the deal will likely involve some kind of financing.

“If you’re not selling to an outside buyer, nobody is showing up at the closing table with a big bag of cash. You’re probably looking at seller financing and you’re going to take back a big note. That’s OK, but you’re not disconnecting yourself from that business from a financial security standpoint,” English says. 

And the experts agree there’s one final item to consider before stepping away: make sure you’re ready. Leaders who think it’s time to walk away only to find retirement is not as fulfilling as expected are legion.