By Dan Schwarz, CPA/ABV
During the life cycle of a business, goals can be drastically different. Early on the goal may be just to survive. After a while, the focus may shift to items like growth, efficiency, and better financial performance. Then one day the business owner may realize they aren’t going to be around forever, so the goal becomes a successful transition of the business. Often, this goal is somewhat reluctantly undertaken. An owner may be uncomfortable with no longer owning and managing the business they have spent years growing. However, not embracing change can prevent the business from a successful transition and may also limit financial benefits to the owner.
As accountants and advisors, clients ask us daily about transition and it is easy to understand why. Demographically, according to Guidant Financials’ 2019 Small Business Trends and Statistics, 57 percent of small business owners are over the age of 50 with 18 percent over the age of 60. These owners have spent their lives building their business and focusing on day-to-day operations. Most owners have never transitioned a business before and are faced with the monumental task and pressure of transitioning the business successfully. Many are unsure where to even start. This article will discuss the various steps of transitioning a business and typical practices needed for success.
We will use a fictitious company, ABC Company, to illustrate common scenarios we see in our advisory practice. Lou started ABC Company 30 year ago. During that time, Lou has taken a hands-on approach to the day to day operations, ranging from driving to calling on customers to negotiating with lenders to secure financing on new equipment. Lou’s management style has been to keep overhead low, wear many hats, and treat his employees with respect as many of them have worked with him from the beginning.
Lou has been married to Mary for 40 years and together they have three children, Nate, Olivia and Peggy. Growing up, the kids have worked in the business during summers to help earn money for school. As an adult, Olivia still works in the business. Her siblings are no longer involved, but Lou keeps them informed with how the business is doing. Over the last 30 years, Lou has experienced the highs and lows of being a business owner. He has been fortunate to accumulate some wealth outside of the business but ABC Company still represents the biggest asset of Lou and Mary’s wealth. Lou still has good health and enjoys going to work every day but recently after having a couple of extremely successful years, he thinks now is the time to transition the business. But many questions arise. How and to whom? Olivia is a natural choice but then what does he do for the other children? What is the business even worth and if so, how does Olivia pay for it? Lou has heard of other companies selling to third parties for seemingly high values but how would he even go about finding an interested party in ABC Company?
Lou faces several of the same obstacles and questions many owners have in transitioning a business. Lou needs a plan. He decides to assemble a team including his CPA, attorney, and banker to help determine and implement the best route for his business and family. After a few months, Lou realizes that while Olivia enjoys what she does, she isn’t prepared financially to buy the company at full value or willing to take on the leadership role he currently has. Lou gathers the team to discuss how to prepare the company for a potential sale to an outside party. The team advises Lou to hire a business valuation expert to determine a range of value of the company. Lou hesitates at first. He thinks he can figure out the value just by making a few calls to his friends in the industry that have sold. After further discussions with the team, he realizes there are several factors that go into valuing a business.
He decides to rely on the expertise of a valuation company with experience with companies in his industry. The valuator shows Lou that the value of the company can vary a great deal based on the company’s structure, customer base, cash flows, employees, and equipment. His biggest realization is that to maximize the value, Lou is going to need to take time to adequately prepare the company to be sold. Lou’s management style has been successful for several years given his goals of keeping overhead low and wearing many hats. Now that he has different goals in place for the future of the company, he realizes he needs to look at certain aspects of the business differently to move as much value as possible from himself to the company. This will not only take time but several tough decisions. After 18 months, ABC Company has changed dramatically. Lou has hired a sales manager to help diversify the customer base. He worked with an accounting firm to prepare audited financial statements so potential buyers have assurance on getting an accurate financial picture. Technology has been updated where needed. Long-term employees have been trained to take on new tasks and if unable to do so, have been treated fairly with a reassignment of duties. While some of these items have added additional costs, they have also increased the value of ABC Company because it has transferred value and knowledge from Lou to the organization. By taking the necessary time and steps, Lou has secured his retirement, provided his family financial comfort, and structured the company for future success, so his legacy can live on.
Transitioning a business can be a difficult and overwhelming idea. The right team of advisors and a shift in goals is key to making it a successful transition. McGowen Hurst Clark Smith has teamed with many business owners to smoothly transition businesses and accomplish the goals of the business owners. We welcome the opportunity to discuss and help you accomplish your goals.
Dan Schwarz, CPA/ABV | Managing Shareholder