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03/22/2010

Entrepreneurial Tip Corner: Will Your Business Be Able To Outlive You?


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Many of us feel like we will be around forever and want to keep our businesses for that long, because we enjoy them so much. Others wouldn’t mind selling their business and either retiring or doing something else tomorrow. Either way, business succession planning is critical to assure that you are prepared for either eventuality.

Figure out who can take over your business and assure your retirement annuity. If it’s a family member, you need to make sure that this family member—typically one of your adult children—has the desire and the aptitude to step into your shoes one day. The desire is at least as important as the aptitude. I have witnessed second generation business owners drive their parent’s business into the ground, not due to incompetence, but rather due to unhappiness or disinterest in the business. I have also seen second generation owners fall prey to the same unfortunate result, even though they loved working in the business. Their downfall was that they did not know how to really run the business, nor were they willing to hire a qualified COO to run it for them.

If you are already in business with a relative or other individual, having a buy-sell agreement in place is crucial. This will ensure that in case of either of your demise, the business will carry on with little disruption. Typically, a buy-sell agreement will be backed by a life insurance policy on each of the owners, with the company as the beneficiary. In this way, the company is able to buy back the deceased owner’s interest in the company from the estate of the deceased owner, with the life insurance proceeds. This method of succession planning assures that the company’s assets are not depleted when buying back the deceased owner’s interest.

Make an alternative succession plan if a family member can’t successfully take over your business. This process encompasses starting and maintaining a good accounting system, entering into long-term sales contracts with customers and placing window dressing on the business in preparation for due diligence by outside parties. Know what your business is worth based upon a multiple of adjusted earnings, a multiple of recurring revenues, or another generally accepted measurement.

Another possible succession plan may involve training an employee in your firm who has the right attitude and aptitude, to eventually replace you at the helm. This person could be granted some stock options or a minority stake in the business as a form of “golden handcuffs” to incentivize them to remain in the business. You could then enter into an agreement whereby this individual continues to run the company, and you are paid a pre-agreed selling price over time, which generally emanates from the annual cash flow of the business.

Another method of succession planning involves hiring or promoting this same caliber of individual, incentivizing them with options or a minority stake, and then trying to sell the business to a third party. The value of the business would be preserved by this individual’s ability to step into your shoes and run the business for the new owner. If you decide to go this route, you should work with an outside consultant to properly prepare your business for sale. Depending upon the size of your business, you should also consider working with an investment banker who will help find the right buyer to both maximize the proceeds from the sale of the business and assure that the business is acquired by the right buyer. Typically, you will be able to derive a higher multiple for your business by selling to a strategic versus a financial buyer. This is due to the fact that a strategic buyer (typically someone within your industry) will be able to consolidate some operational activities, thus reducing the marginal cost of running the combined business. A reduced projected cost will result in a higher projected earnings number, which in turn will result in a higher overall selling price.

Know ahead of time what to do with your business and how to do it to ensure that your business will outlive you and serve future generations.


--Michael Herz, CPA, MBA

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