The exit plan for transitioning your business to your children is not exactly the same as selling your business to a third party, but effective exit plans for these two situations have more in common than you may realize.
Let’s assume your retirement plans are dependent on a cash sale of your business to a third-party buyer. For the business to command the highest price at exit, it must be considered a ‘best in class’ operation. The farther a business is from this status, the less a buyer will pay for it. There are several aspects involved in being a best-in-class business, among them are having high performing human capital, as well as well-developed, documented processes, procedures and systems. Effective exit planning will help you identify the value drivers within your business, and implement a plan to develop those value drivers to achieve maximum value.
Now, if you are not selling to a third party, but instead you are transferring the business to your children, and want them to be successful in managing it without you, then exit planning to become a best-in-class business will be as important as preparing the company for sale to a third party. If your children are going to be successful in running the business without you, you have to create an organization that can function at full capacity without you, before you transition the business to your children.
For effective exits in all cases, we recommend you develop high performing human capital and well-developed and documented processes, procedures and systems. This means your management team, now consisting of your children, will be equally as effective in managing the business without you, if you want them to be successful. This is done through effective training, development, delegation and accountability. An effective exit plan will determine the knowledge and skill gaps in key managers and establish a plan to fill in those gaps, regardless of whether the management team is family or not, and regardless of who is acquiring your business, your children or a third party buyer.
Some of the more notable differences between exit planning for selling to a third party versus transitioning to children are: family dynamics, estate planning matters and other sensitive family issues that may be unique to transitioning the business to your children. There will always be family dynamics around wealth creation, be it the business or the wealth resulting from the sale of the business. Estate tax planning is still necessary in exit planning, regardless of how the exit is accomplished. The owner’s personal and financial goals will need be thoroughly addressed in every effective exit plan, no matter who acquires the business.
The other more common matters that arise in exit planning with children-successors that do not arise with a sale to a third party are entitlement and competency issues. Entitlement issues arise when some only some of the owner’s children work in the business as employees. The children outside the business often believe they are equally entitled to benefit from the income of the business, due to their potential inheritance of ownership. The children who work in the business and take over management from the parent may have a different view. They may believe the benefits of the business belong to those who are working in it every day, generating the profit and contributing to the success of the business, and not to the siblings who do not work in the business. An effective exit plan, which begins long before an ownership transition takes place, does not decide which side of this argument is correct. Instead, it is transparent to all stakeholders, includes the voice and concerns of all family members and amicable solutions that involve all children in the owner’s exit planning process.
The second common issues with transitioning the business to children is the competency issue. In many cases, the person who is most competent to run the business when the owner retires is not necessarily a family member. Having a non-family member become the president or CEO may be astute from a pure business perspective, but may cause severe problems with family harmony. Children who work in the business often expect to manage it when the parent retires. The children may find the idea of having a non-family member as their new boss to be unacceptable. However, promoting children to positions they are not yet qualified for may cause disruption in the business, causing more talented non-family members to leave, and decrease business success. Effective exit planning considers the skill gaps of all key managers, regardless of family association, implements effective training to eliminate skill gaps, and plans for successful business continuity as well as family harmony.
Keep in mind an effective exit plan will serve several purposes and should be started very early, at least three to five years before the owner plans to exit the business. One purpose is to determine the role of the business in the owner’s personal and financial affairs, including funding the owner’s retirement for the rest of their lives. Another role is to make certain the business can function without the owner, as a best in class business, regardless of who takes over the business. The exit plan will create a course of action to make certain the business owner, the management team and all professional advisors are working in unison to make the owner’s goals and plans come to fruition. Exit planning establishes a process for a successful business transition, be it to a third-party buyer or to the owner’s children.
Rich Gunn is the leader of BPM’s Value Acceleration Service Team, which helps with succession, transition and exit planning for business owners. Rich is a Certified Exit Planning Advisor and member of the Exit Planning Institute.
The Business Owners’ Special Series (B.O.S.S.):
The Business Owners’ Special Series (B.O.S.S.) is a library of articles for business owners who are proactively seeking guidance from experts on how to implement value acceleration in their business. Be sure to keep reading, if you desire to develop your business to its maximum potential value and gain an understanding of how and why beginning the process sooner results in building greater value.