Although it is the single greatest financial event of a business owner's life, the transition of ownership in a company rarely receives its due consideration and time. The apprehension of one's retirement or the oversight of other untimely events often clouds the opportunity at stake: strategic transition planning can be a catalyst for company growth even as the owner departs. Indeed, before stepping out the door, an owner can gain the security to know that his legacy will continue to thrive.
As part of Decosimo's Strategic Transition Planning Team, Mike Costello and Ben Doak recently met with a septuagenarian owner of a chemical plant. He approached the team having designated a key employee whom he had hoped would carry forth the operations of the plant. The owner was prepared to begin the transition next year, for a phase-out period of ten years. The owner would retain majority interest in the company, while progressively scaling back the time he would put into its operations.
The Decosimo Team's role was to listen to the owner's transition goals and to educate him on relevant risks and opportunities.
His story will illustrate that exit planning is like any other financial decision. A smooth transition of a strong enterprise requires careful planning, as well as an appropriate understanding of the matters involved, from estate planning to valuation, tax strategies to financing.
Typically, exit planning is the joint effort of members of a CPA firm, a family business attorney, a financial planner/wealth advisor, a banker, and other specialists, such as business valuation specialists or insurance professionals. Decosimo has built a strategic transition planning team comprised of estate planners, business and personal tax planners, valuation professionals and business advisors (Decosimo Advisory Services- a division of Decosimo CPAs known as DAS) and life insurance consultants to coordinate with our clients' other advisors.
The planning began with a typical, but critical question. "What is the appropriate price to be paid for the owner's interest in the company?" This called for a valuation of the enterprise by DAS valuation consultants.
Having placed a value on the interest, the valuation also allowed the team to identify areas where company operations could improve to add value to the enterprise and to increase its operating efficiency. A DAS professional noted inefficiencies in the company's operations, and consulted the owner with long-term plans to maximize profitability and cash flow growth, while also protecting business assets.
In terms of risk, owner successions can rattle a company's internal structure. It is not always clear how a new owner will manage a company or whether the change will result in management dispute. The team therefore considered long-term strategies for preserving management interests in the company.
This type of risk is often called "key employee risk." Key employee risk concerns the pitfalls of having employees participate as vital components to company operations. In such a case, the employee's departure may place the company at risk of failing to retain the same level of profitability. Such an employee may also use his or her knowledge of the company's strategies to start a competing business, thereby posing a new threat to the enterprise.
The valuation also allowed our team to identify the key managers and their strategic importance to the company. The team then suggested that the owner provide new incentive plans, such as provisions for life insurance, a cash bonus plan, and a phantom equity plan, where employees would receive a bonus based on company performance. By providing management with long-term incentives, the owner had an opportunity to ensure strong management well into the future.
The team understood that the designated successor would not have the financial basis to purchase the company outright. Even though the owner indicated that he was willing to receive less than the fair market value of his company, the team indicated that there also existed a potential conflict of ownership under the current plan, as the new owner would not have a controlling interest. An investment banker (Decosimo Corporate Finance, LLC- Member FINRA/SlPC) educated the owner on other opportunities, suggesting contact with buyers seeking financial or strategic goals in an equity purchase or other financing resources.
Finally, with the help of an estate and tax planner, the team devised a tax efficient plan to receive cash flows in exchange for the company interest. The plan prepared for alternative circumstances, such as in the event of his death, and further advised the owner on how to resolve current debt obligations.
Each strategic transition plan is designed to cover the broad range of options invoked in an ownership transition and meet the specific goals of the owner. An effective transition is efficient, thoroughly considered, and tailored to the unique needs of a company. Although transition planning will sometimes be met with apprehension for the longtime business owner, there are fantastic opportunities to seize given appropriate time, foresight, and an effective strategic transition planning team.
To discuss a business transition and obtain a better understanding of how to transition the business in a way that maximizes value, contact Decosimo’s Strategic Transition Planning advisors in confidence at 800.782.8283 or by email at email@example.com.