Business owners work for years to build up a business that they are proud only to come to the grim realization that they will be walking away from it all upon retirement. But transitioning the business doesn’t have to be a scary thing when you know what options are available. With appropriate planning, the transition of both management and ownership can happen over time, allowing the business to continue to evolve with a contribution from both the old and new owners.
Business owners often have specific ideas about not only how they want to exit the business, but how they wish the business to continue to operate. This is why our last post focused on having business owners start succession planning by focusing on two questions: how much do you need to retire? And who would you like to take over the business? Once you have considered those two questions, you can start to determine how the transition of the business will be done. In this post we will discuss some of the most common methods used to transition a business along with the benefits and challenges of those options.
Passing the business to the next generation
Passing ownership of the business to the next generation is a popular option as business owners want their family to benefit from their business’ legacy. This option can also be the most difficult to achieve due to complex family relationships. The business owner must consider:
- How much of the business will be purchased by the next generation upon retirement and how much will be gifted as part of their inheritance?
- What role will the next generation play? Will they own and operate the business or just have an ownership stake?
For business owners with more than one child, these decisions become more complex. The business owner wants to be fair to all his/her children, but also wants to ensure the business continues to succeed and benefit future generations. It is important to remember that fair does not mean equal. Allocation of different classes of shares of the business can allow ownership without employment and therefore their children can benefit from the growth they generate. Children with the appropriate skill set can also be offered employment in the business. With a more complex corporate and family structure, it is often helpful to involve advisors to help prepare and present the plan to the family in order to maintain effective communication and strong family relationships through the transition.
Transitioning the business to key employees (also known as a management buy-out)
Some business owners have a group of dedicated employees who have helped to build the business. This may lead the owner to want to reward those key staff with the opportunity to take over the business when he/she retires. Under this option, you will know whether the group of key staff have the skills to run the company, but you must also consider whether they have the ability to work together and are willing to become business owners. Therefore if this is the option you wish to take, it is important to discuss this openly with the key staff early on. You must also consider how the buy-out will be funded and the impact on any employees not offered the buy-in. Again if this option is selected, it can be beneficial for an outside advisor to help communicate the plan and options to those key staff in a non-emotional manner.
Selling the business to a third party
Simply selling your business can also be an option to allow you to profit on the successful business you have built. It can be challenging to find the right buyer and trust them to take over your company. However, when the right buyer comes along, you should be prepared with at least three years of strong financial statements prepared by a public accountant. These statements are key to any sale as they will be used by the buyer to help determine the value of the business (supported by a business valuation) and to complete due diligence. Under this option, you must also consider the terms of the sale agreement. Are you willing to stay on as an employee or consultant for a period of time after the sale? If so, how will you be compensated? Will you sell the shares of your company or the assets? How much is your business worth? How will you structure the payments? So as you can see there are still many things to consider before you exit the business through a third-party sale.
It is important to note that all of the options provide a way to keep a component of control or be paid out over time. This can be achieved through maintaining a class of voting shares, share redemptions or promissory notes. As each has benefits and challenges associated with them, it is important to consider all the possibilities and get advice from your advisors before including such arrangements in your succession plan. You must decide what strategy is best for your peace of mind as you enter retirement.