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4 Valuable Strategies for Business Succession Planning

May 8, 2017

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Despite your affinity for your business, retirement has to come sooner or later. For many business owners, this raises a few big questions, including the logistics of an exit plan. There’s no one right answer here as every business is an independent entity, but some options are better than others. Here are four business succession strategies that provide the most value.

1. Initial Public Offering (IPO)

Going public is less common than it used to be, and is generally a strategy favored by large businesses with a distinct need for capital. Nevertheless, making the move to being publicly traded can effectively help a current owner to transition out of company ownership.

Pros

In the right market, an IPO can provide significant ROI and the financial gains are virtually unparalleled, often exceeding what a company could get in a private sale.

Cons

Immediate liquidity is not likely with an IPO, as shares must be held for a certain period of time. Also, the legal process of going public is extremely complex, requiring a significant investment into ensuring all compliance benchmarks are achieved. Market conditions need to be perfect, too, for a company to truly benefit. 

 

2. Management Buyout

In a management buyout or MBO, current management pools together their resources to purchase most or all of the business.

Pros

An MBO offers instant liquidity and can eliminate the legwork of shopping for buyers. Additionally, current owners likely already know and have faith in these individuals, making it a little easier to pass on the torch.

Cons

This process can be time-consuming especially if management needs to raise capital. Additionally, current management needs to have strong strategic skills to both keep the business moving forward and account for any debt that went into the sale.  Finally, selling to management can be risky, especially if the deal does not go to completion.  Managers can become discouraged and walk away from the business leaving it weaker than when the process began.

 

3. Third-Party Sale

A sale to an outside third-party buyer may allow a current owner to wash his hands of the business entirely. This strategy is typically a sale in full with no option for partial ownership. Often a financial buyer will require the seller to finance part of the sale.

Pros

This option can offer immediate liquidity, as the entirety of the business is generally sold in one fell swoop. For companies with multiple interested bidders, a third-party sale can get competitive, offering you more than you anticipated for your company.

Cons

For owners who want to stay involved in company operations, selling to a third-party probably won’t provide the right flexibility. Sometimes full liquidity cannot be achieved.  For example, Private Equity (PE) groups will generally require the former owner to reinvest part of his proceeds back into the business vs. keeping it for himself.  Former owners have little to no say over future activity, including the overall direction of the business. In addition, the effort that goes into finding a buyer, negotiating, and drawing up paperwork can be costly and time-consuming, with no guarantee you actually make it to closing.

 

4. Employee Stock Ownership Plan (ESOP)

A trust that can hold shares of stock to distribute to employees as a tax-deferred benefit, ESOPs spread the wealth of ownership among all qualifying employees.

Pros

ESOPs offer significant advantages to exiting business owners. First, the selling owner remains in control of determining his position, staying involved in management as long as desired. Full ownership doesn't have to be sold to an ESOP, allowing an owner to exit the business slowly over time. Confidentiality isn’t an issue either, as all proprietary business knowledge stays within the company. ESOPs can boost employee morale as well as stand within the community, as a transition to employee ownership is often seen more favorably than a third-party sale. The probability of closing is also far more assured, as there’s no risk of an ESOP backing out or repricing a deal after due diligence.

Lastly, tax benefits with an ESOP can be significant, providing deductions companies can use to offset tax liabilities and ultimately reduce annual payments.  100% owned ESOP companies can even become “tax-free” organizations for federal income tax purposes.

Cons

Transaction valuation may be lower with ESOPs, as the price of the Company is limited to Fair Market Value and not strategic value.  Additionally, while less expensive than selling to a third party, the costs of implementation and administration can be pricy.

While there’s no universal answer to the cessation of ownership, ESOPs offer many compelling advantages, from a controlled transition process to strong tax benefits. If you are looking for a way to exit business ownership without sacrificing total control over your business, an ESOP can help you make the best decision possible for you, your company, and your employees.

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Herbert Kalman

Written by Herbert Kalman


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