Planning ahead: Hire your successor

October 17, 2017 -  By
Photo: ©istock.com/EnriqueM

Photo: ©istock.com/EnriqueM

The sale of your business likely isn’t going to happen the way you expect, so plan for it.

Many business owners believe they’ll be able to sell their businesses and monetize what’s often their largest and most important asset when they’re ready to retire. Unfortunately, a sale isn’t likely going to happen the way an owner expects.

First of all, many businesses listed for sale—about 80 percent according to BizBuySell—never sell. Some experts estimate it’s even higher. Some businesses are listed to test the waters and might include unrealistic asking prices. They’re listed just in case the seller can get a certain price, no matter how unlikely. Many businesses that are listed for sale aren’t attractive to a buyer for any number of reasons, including poor industry prospects, poor financial performance and a significant dependence on the current owner.

Many businesses for sale are priced at unrealistic values because an owner believes the business is worth far more than the market will pay. This often happens when an owner relies on what he believes are industry norms or when he has been told how much other similar businesses have sold for, which may or may not be realistic.

For example, many lawn care (fertilization and weed control) company owners believe their businesses are worth a minimum of $1 for each $1 in revenue, without regard to the profitability of their business. This has never been the case and is certainly not now. At one point, it may have been true that a lawn care business of average profitability of a certain size could draw that kind of offer, but it was never as broad a value model as many lawn care business owners believe to this day. Not long ago, I had a long conversation with a retirement-aged business owner seeking to sell his business. Unfortunately, I had to break the news to him that his business was worth no more than 25 percent of what he thought it was.

For small businesses with selling prices less than $500,000, fewer than half of the transactions in which a tentative agreement is reached actually close. The buyer may discover information during the due diligence process that diminishes his interest and causes him to reduce or withdraw the offer. The buyer also may be unable to obtain financing. Some sellers back out because they finally understand the emotional and financial impact of selling their business and its tax ramifications.

Generally, companies with a large percentage of recurring revenue are much more attractive to buyers and draw higher selling prices. This includes fertilization and weed control companies and landscape maintenance companies, especially in the commercial landscape maintenance market. Others, including design/build companies, are more difficult to sell, even though they’re successful. In addition to not having recurring revenue, many landscape businesses are owner dependent, which is a main reason they may be difficult to sell. Many landscape firms derive much of their income from the owner’s reputation as a designer, raising concerns about what happens if that designer is no longer the focus of the company.

Look inside

With these hard-to-sell cases, there are often many advantages of an inside sale to an employee. A sale often can be accomplished without drawing undue attention to the changes in the business, which create uncertainties for employees and customers and perceived opportunities for competitors. The risk associated with not closing because of due diligence and financing is usually greatly reduced.

Emotionally, an inside buyer can be satisfied that the business he has built will continue and customers are likely to continue to receive the level of service to which they’re accustomed. The value with an inside sale is sometimes equal to or a bit higher than a third-party sale because the perception of risk to the buyer is lower.

I always ask clients when we begin exit planning if there are any potential inside buyers. The answer is usually “no” because the owner believes an employee would never be able to finance an acquisition. That belief often is misguided. You really don’t know what resources might be available to an employee. I’m often surprised. With one design/build business sale I handled recently, the buyer was the bookkeeper’s husband. You really never know.

If you don’t have an inside buyer, one alternative is to hire your successor, which requires careful planning but might be your best option.

Here’s how that can work:

  • Define the characteristics you’d look for in a successor and build a job and job description with those in mind.
  • Recruit a person who meets those requirements to be your second choice.
  • Recognize that empowering your second choice is an important step in building value in your business, regardless of whether your second choice succeeds you.
  • After you’re comfortable with your second choice, develop a transition strategy that meets your goals and is appropriate to the circumstances.
  • Implement a plan that allows your new successor to acquire the business over time. There are several strategies to accomplish the sale, including some that make third-party financing more viable.
  • Retain control of the business during the transition until you’re paid or mostly paid. Don’t even rule out the possibility of a third-party sale if the right circumstances occur.

Any sale of a minority interest raises special concerns. What if things don’t work out? What are the rights of a minority owner? How are disputes resolved? What happens if one of you dies or is incapacitated? What if you become sick of each other?

These and other issues need to be properly handled and documented legally. Any promise of an equity interest needs to be in writing.

This succession process requires thought and planning and includes your tax and legal advisers, but it’s a real option, especially for those business owners whose businesses fall into the hard-to-sell category, which includes many lawn and landscape businesses. If you don’t think you can find an internal or third-party buyer for your business, hire one.

Photo: ©istock.com/EnriqueM

About the Author:

Edmonds, a corporate finance professional with experience in merger-and-acquisition transactions, is the principal consultant for The Principium Group. Contact him at redmonds@principiumgroup.com.

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