Whilst those in M&A readily talk about their successes, the reality is that not every business gets sold.

The reasons are many and varied, and they hold the key to what owners should do if they find themselves still on the shelf after a year or so of being on the market.

Although there may not necessarily be anything wrong, usually reasons can be found in one or more of the following areas:

1. Is something wrong with the business?
2. Is something wrong with the price?
3. Is something wrong with the way it is being marketed?
4. Is something peculiar about the industry the business is in?
5. Is it still too early to expect a result?

To help owners analyse their situation, here are some possible areas to explore under each of the above headings and suggestions as to what can be done about it.

Only 20% of all of the businesses listed for sale ever sell*

90% of all of the people who begin the search to buy a business never complete a transaction*

These US small business sales benchmarks* would apply equally to the Australian small business market, and to a slightly lesser extent, to larger businesses.

The reasons for these atrocious statistics are many, but include the industry’s over-reliance on passive web-based marketing and the under-utilisation of targeted B2B marketing.

It is for these reasons that we have invested heavily over more than 21 years and over $5M in our M&A database, so we can actively target strategic buyers for each business. This allows us to achieve for our clients the best possible success rates, well above industry averages and substantially better than 80% of all clients taken to market.

In fact we won’t take on the responsibility of selling a client’s business unless we can identify and target substantial numbers of strategic buyers for that business (how to do that is explained below).

What could possibly go wrong in M&A?

Imagine if every single action you ever undertook in M&A resulted in immediate and positive outcomes.

Without the right tools, M&A can be a massively wasteful process for everyone involved. Even at its most efficient, with the right tools and a successful outcome, the M&A process may be only 10% efficient and 90% waste. At its worst, 100% of all activities could be wasted if there is no resultant deal done.

Imagine if every business for sale was investigated by only one buyer. The perfect match! No wasted effort, no dry gullies, no unproductive marketing. Just ‘tap and go’ with ‘The Buyer’.

Yet even with the perfect process, the product you are selling (the business itself) is imperfect and things can be wrong or go wrong, leading to a potentially wasteful process with an unhappy ending.

No matter how good the M&A Advisor and processes are, if the client’s business performance goes down, everyone goes down with the ship!

Putting business performance aside, the list of potential waste generators in an M&A process is practically limitless. Here are some examples of the pitfalls and how to avoid them:

Buyers may:

• Investigate hundreds of businesses without buying any of them.
• Target businesses priced beyond their financial capacity.
• Not take the time to find out their financial capacity before starting to investigate businesses.
• Not know what they are looking for or how to find it.

Solutions for Buyers:

• Decide on their target market profile and confirm their financial capacity BEFORE starting to look for a business. If you don’t have your own agenda, you’ll end up being carried along by those that do.
• Instead of wasting time sifting through opportunities randomly, engage in a systematic search of ALL businesses matching the target profile, rather than limiting only to those that are currently on the market. More than half of all business owners will sell if approached by or on behalf of genuine purchasers. This is because most businesses where the owners are willing to sell are not actually on the market and owners are attracted by the thought that a genuine buyer will allow them to short-circuit the potentially wasteful open M&A process.

Owners may:

• Engage M&A advisors who have no processes, knowledge or marketing capability.
• Try the DIY approach and end up in a mess.
• Not take the time to prepare properly, and therefore not optimise their financial outcome.
• Engage the wrong accountants or lawyers, disrupting or sabotaging the sale.
• Not obtain quality tax advice and end up paying more tax than necessary.
• Not be fully committed to the sale and pull out at the last minute.
• Not be properly briefed on how extensive the process will be, including due diligence.
• Not have adequate records, financial integrity or formalise commercial arrangements.
• Set too high a price and miss out on selling to those who could afford it, if it were priced realistically.

Solutions for Owners:

• Research and engage the right advisors, performing their own due diligence on who to engage to assist them.
• Ask a trusted advisor.
• Perform a google search of the prospective advisory firm’s [NAME] + [ACCC] (for Aus only). Some high profile business brokerages will show up as being renowned marketeers through that very simple check.
• Apply criteria such as these: https://divestmergeacquire.com/partner/#member-firm.

M&A Advisors may:

• Try and take short cuts and fail to market the business adequately. This article compares the various ways to market businesses: https://divestmergeacquire.com/sale-process/how-to-market-and-sell-strategic-businesses/
• Not properly qualify or advise clients, to ensure their expectations are realistic.
• Not check whether the owner has received proper tax advice and know the after tax outcome for a given price.
• Not prepare a comprehensive Information Memorandum so buyers can properly assess the opportunity.
• Invest/waste copious amounts of time manually researching possible targets.
• Target the wrong markets or not target any markets at all!
• Source and interact with a large number of responses and expressions of interest from buyers before finding one or more willing to proceed.
• Not properly qualify buyers for financial capacity and/or suitability to operate the business.
• Invest copious time and money and not sell the business.

Solutions for M&A Advisors:

• Be on top of your game. Be part of a professional organisation or network with proven systems, processes, documentation, training, resources etc., such as our own  M&A advisory network: https://divestmergeacquire.com/partner/#member-firm
• Properly market opportunities to identify and target the right buyers.

Everyone may invest time and money on the process, to find:

• There is some legislative, legal or commercial reason why the business is unsaleable.
• The business performance has taken a dive and is now not attractive to either buy or sell.
• One or more key employees or customers leaves at the 11th hour, or potentially worse for the buyer if it happens just after the transaction.

The list of what can go wrong in M&A is endless.

Having the right M&A team, advice, processes and resources are essential to optimising outcomes….and beating those odds!

*References: 

1. “Industry Statistics Every Buyer Should Know”, by Richard Parker, published in BizBuySell in alliance with Wall Street Journal

2. “The Business Reference Guide”, by Tom West 

3. “How to Plan and Sell a Business”, Jim Stauder

How to structure business sale transactions to create bonus value for all parties

This model delivers spectacular outcomes when a business is sold.

Reduced risk, easier negotiation, smoother transition, optional team involvement, higher overall price and long-term value, enhanced growth and stronger teams …this model ticks all these boxes and more!

With the right approach and mechanisms and a little effort, tailoring up an optimal structure can deliver spectacular outcomes to all stakeholders where business owners are retiring.

Here are some basic elements and benefits:

Reducing risk

A Vendor can often retain a share of their business (eg 20%) for free. This is because of the added overall business value due to the reduced risk from the Purchaser’s perspective.

The amount or proportion retained should be high enough to mean something to both Purchaser and Vendor, but not so large as to be unduly risky to the Vendor, who is relinquishing absolute control to a relative outsider.

The Vendor can hold the ‘bonus’ 20% of the business as a shareholder without additional liability provided they do not become directors or officers.

This can be immensely comforting to the Purchaser, as the Vendor’s mid-term objectives are aligned with their own and that the Vendor will be available to assist at critical times.

This has been covered in more detail in a previous Divest Merge Acquire article: https://divestmergeacquire.com/articles//how-to-retain-20-equity-in-your-business-for-free/

Easier ‘Sell’ and smoother transition

A key risk in any transaction is the potential disruption caused by a change in ownership. Employees may become spooked and customers and suppliers may reassess their positions. If handled poorly, the perceived uncertainty can wreak havoc on a business and wreck the sale.

By retaining an interest in the business, Vendors can make the transaction an easier ‘sell’ to customers and employees. As the incumbent owner is retaining a share, they are effectively “bringing in an investor to take the business forward”. The clear message to customers and staff becomes “I’m not going anywhere for the time being, so it is business as usual apart from some positive changes.”

How and when you communicate the sale to your staff is also a key factor in reducing uncertainty. If poorly handled, key staff may jump ship, destroying business value for both the Purchaser and Vendor and possibly even sabotaging the sale.

Recommended approaches are outlined in Divest Merge Acquire’s article: http://divestmergeacquire.com/articles/who-do-you-tell-when-youre-going-to-sell/

Easier negotiation – Positions Purchaser and Vendor on the same side

If the Vendor is retaining a stake in the business, negotiations become instantly easier the moment the Purchaser realises they are negotiating with their future business partner. Why would you want to screw the last drop out of the deal when there is enough upside for everyone and you want the Vendor and their team to have a happy and lasting relationship with you? The parties become more flexible during the negotiation if they are proposing to become business partners for a period of time.

Vendor’s future role is rewarding and builds value

In many instances, retaining an ongoing interest in the business enables the Vendor to enjoy a phase out period and transition from ‘process to projects’, by being freed up from the day to day routine and admin etc, and being able to add value by undertaking training, business development and exploring other growth opportunities by using their extensive knowledge and perspective in the most valuable and rewarding ways.

Many former owners find this among their most rewarding times in their careers, as they get to do all the things they enjoy most, impart as much knowledge as possible and play a key role in seeing their business grow towards the future.

Contrast this to the difficulty some Vendors have when they continue to work in their old business but no longer have the status of ‘owner’ and instead are merely part timers or consultants. Retaining some ownership makes the transition much more palatable and allows them to retain some of their former status as owners.

Potential for more financial upside for the Vendor

The Vendor has the opportunity to continue to add value and share in the further success of the business. Depending on the Purchaser and their growth ambitions, the final settlement transaction can be far more lucrative than the Vendor would have ever been able to achieve if the sale had not been staged.

Including key managers provides further benefits

The Vendor equity retention model laid out above can easily be expanded to accommodate key managers.

Scenarios that have proved successful include where the Purchaser and Vendor each allocate (gift) a small % of their shares to willing key managers. The key managers may also have the ability to invest their own funds. In most instances, their shares have a special category without voting rights.

Divest Merge Acquire has previously covered some of the scenarios that can be built in to accommodate key managers: https://divestmergeacquire.com/other/how-to-help-your-team-to-think-and-act-like-owners/

The benefits of this are substantial and can make (and have made) the difference between a transaction proceeding or not.

Not only do the key employees have greater commitment and ‘buy in’ to the business transition and the future, but they are far less likely to leave, which reduces a substantial risk of them becoming competitors. It also brings them into the transaction as receiving consideration, thereby making any restraint built into their employment contracts far more likely to be enforceable.

If equity is not an option, a more watered down approach could involve employee retentions. Such retentions serve to keep key employees with the business for agreed periods, but with a significantly reduced ability to align employee objectives with those of the Business Owners. For more information on employee retentions, refer to https://divestmergeacquire.com/sale-preparation/keeping-key-staff-when-selling-a-business/

Retaining a share of the business vs a pure earn-outstructure

Retaining a share of the business for a period of time is generally superior to the simpler and more traditional approach involving only an earn-out. Under a pure earn-out structure, a portion of the sale price is contingent on future performance outcomes being met. The intention of an earn-out is primarily to transfer some or all of the risk to the Vendor. But there can be serious downsides and very few positives. The outcomes are usually no longer under the control of the Vendor, especially when control of the business has transferred to the Purchaser even before the earn-out period commences.

Earn-outs can also promote friction between Vendors and Purchasers, where Vendors are focussed on fixed short-term criteria and Purchasers are more concerned with long-term sustainability and growth. They also tend to limit the Purchaser’s ability to inject capital or make other changes during the earn-out period, as there is an element of custodianship and Vendor resistance to take into account.

Structure the arrangement for further investment and eventual exit of the Vendor’s remaining equity interest

In situations where both parties have agreed the Vendor should retain an equity interest, it is important to establish defined strategies and options for both parties in agreed timeframes.

The Shareholders agreement (SHA) should set out how to handle future transactions. Key considerations include:

Initial Transaction element

Purchaser initially acquires up to 80% of the business based on an agreed Enterprise Value (normally calculated according to a multiple of earnings (EBIT multiple).

Provide for further Capital Injections

Make provision for Vendor to either match the Purchaser’s capital injections or allow their % shareholding to dilute.

Prepare for exit by either party – Sunset provisions to resolve future outcomes

i.       Drag along and tag along rights (“drag and tag”)

If the purchaser wants to sell while the vendor still holds a share, then the vendor can tag along, or can be dragged along to sell.

 ii.      Call Option after an agreed period

The purchaser can exercise a call Option to acquire the remaining shares at any time or within an agreed period, with the price set according to a pre-agreed multiple of earnings (EBIT).

If the business has gone well, then the price will be higher, but in theory the Purchaser should have the capacity to complete the acquisition due to the profit earned over the period.

iii.    Put Option

The Vendor can exercise their Put Option after an agreed period, eg 3 years, requiring the Purchaser to buy their remaining shares according to the pre-agreed formula.

The exercise price is based on agreed multiple of EBIT.

Documentation

Many, but not all, lawyers can handle this. We are happy to recommend those who are familiar with this structure.

Conclusion

With a little effort, the right tools and advisors on board, it is very easy to achieve a smooth business transition, a higher quality outcome and provide ongoing benefits to all stakeholders.

It is no wonder that, after this model is explained to the parties, it is widely accepted and welcomed by Purchasers and intending Vendors alike.

When selling a business, a primary concern of both the seller and buyer is how to retain key staff. Losing key staff can be catastrophic for any business, and is likely to cripple a sale process. So how do you ensure they stick around?

Employees handle uncertainty regarding their futures in different and sometimes unpredictable ways. Some leave prematurely, often to less satisfying roles with other organisations.

Despite the inevitable uncertainties during the sale process, it is usually in their interest to stay with the business and the new owners. New owners are often larger firms offering broader services, new opportunities, growth plans, capital, promotional opportunities, scope for travel and diversity. The new owners are likely to be more dependent on key staff than the previous owners were, so they now have an opportunity to shine through. It makes sense to encourage key staff to remain committed during and after the sale.

Staff retention and integration is always high on the priorities for intending new owners, so key staff will need to be involved in the sale process and meet the intending new owners at some stage. For more information on this aspect, refer to Divest Merge Acquire’s article Who do you tell when you’re going to sell.

So how can you ensure staff retention during and after the sale?

One way to encourage key employees to stay during a sale process and afterwards with the new owners is to offer a retention bonus.

The aim of a retention bonus is to align the interests of each of the 3 key stakeholder groups and enhance value for all involved:

• Sellers – want to sell and exit. Having key staff in place makes the business more valuable and saleable, and also allows them to shorten their post-sale handover period;

• Buyers – want to retain knowledge and expertise, relationships with customers and suppliers, overall capacity, and have a smooth transition with minimal disruption to the business. Having the key employees incentivised to stay gives both the employees and the new owners encouragement to work together and manage through changes and any unsettling times.
• Employees – new ownership usually offers upside for key employees. They are in the spotlight and may become the ‘experts’ in the absence of exiting working owners. New owners usually herald new opportunities, growth plans and the removal of previous “handbrakes” on growth. The extensive opportunities can often be masked to employees by the inherent perceived uncertainties throughout the process, and additional encouragement may be needed to see the full picture. This is normally an exciting period for those who stay on.

Aligning the goals of all parties with a retention bonus

Any retention bonus should be transparent to all 3 parties and is generally financial in nature.

It is important to structure the bonus effectively.

There is no point paying it all out as soon as the sale occurs or staff may then leave. Such a structure aligns the interests of both employees and the sellers, but not the buyers – whose perceived risk would actually increase knowing employees will receive a lump sum immediately with no longer term incentive to stick around. Ignoring the interests of one or more parties is often be enough to jeopardise the sale, and would therefore be self-defeating.

The recommended structure of a retention bonus is to pay one component on settlement, and a second contingent component after an agreed period of time (eg. after 12 months), provided the staff member is still employed in the business.

The rationale for offering a retention bonus is also important. A cynical view would be that it is to bribe employees to stay and work to the agenda of both the seller and buyer. However a more positive view is to consider it as a ‘thank you’ for contributing to enhancing the value of the business over time, for participating in the sale process and agreeing to assist new owners settle in.

When preparing to offer a retention bonus, it is important to consider the tax structure of the deal and how to optimise this for both the payer and payee. Any payment is likely to be taxable income to the recipient, but if the company shares are sold, it may or may not be deductible to the seller. You should obtain advice from your accountant/tax specialist on how to best structure these retentions under your circumstances.

Are you or your clients looking to sell a business? You may be interested to know that it’s possible to sell your business at a price equivalent to a 100% sale, but still retain a minority ongoing interest – at no cost!

To see how this works, business owners intending to sell should put themselves in the shoes of the buyers.

As with all investments, business value is a factor of risk and return. Imagine you are buying a business and the owner wants to sell and depart quickly. The risk to you as the incoming owner is higher than if the current owner is keen to stay involved in the business after the transaction for a number of reasons, not the least of which include:

• Buyers will generally have only a short transitionary period from which to draw on seller’s expertise, learning the ropes on day-to-day operations, understand their perspective on future growth strategies and integrate themselves completely into the seller’s role and company;

• Buyers risk losing key relationships with suppliers and clients which the outgoing owners had developed over years of experience;
• Sellers generally speak about the huge opportunities a business has for future growth. This prompts buyers to ask the question: why then are they so keen for a quick exit?

Now imagine the owner is not only happy to stay around for an extended period, but is also prepared to retain equity in the business, however small. Miraculously, most of the above risks reduce considerably or disappear altogether, and acquiring the business presents a significantly safer proposition.

As with any investment, reduced risk should make the business more valuable to the buyer. Not only could this make the difference between the sale proceeding or not, but most buyers are prepared to pay more to significantly de-risk their investment.

How does this work in practice?

As an example: You are the buyer. The outgoing owner is prepared to retain a 10-20% interest.

If the former owner’s ongoing involvement is deemed to considerably reduce your risk as a buyer, it adds perceived value to your investment and the business is generally valued more highly as a result. As you are getting more value, you are likely to be prepared to pay on a higher multiple.

Depending on the extent of the increase in value, this higher multiple may translate to the purchase price of an 80-90% share being equal to or higher than the amount you would otherwise have paid for the full (but riskier) 100% if the owner was making a complete withdrawal of both labour and capital.

Conversely, the outgoing owner effectively retains (or buys) a share of their own business for free!

When structuring a business purchase or sale transaction you have two basic options: Asset sale, or Share sale. While the choice may sound simple, choosing the wrong structure can drastically impact the after-tax position of both buyer and seller, making what was an attractive offer look all but disappointing in their respective bank accounts.

In the Australian M&A market for top-end SME’s, transactions are structured either as Asset or Share Sales in roughly equal proportions. There are many reasons for and against the sale or acquisition of assets vs. shares.

This article is intended as a high-level guide to flag some of the key factors for consideration under each of these structures. When buying or selling a business, it is critical to obtain independent advice from accounting, tax and legal advisors prior to committing to a particular structure to ensure the best choice is made.

Under both sale structures, the valuation and price negotiation is usually based on the unencumbered Enterprise Value (EV) regardless of the final transaction structure.

Asset Sale

Under an Asset sale, the assets of the business are sold and transferred into the buyers trading entity. In this scenario the seller retains ownership of the current trading entity and company structure, and all business assets are transferred to the purchaser, ie. plant and equipment, stock and WIP, business name and other IP, goodwill.

• Although trade debtors and trade creditors are not usually sold, they are almost always included in the net working capital calculation as part of the overall EV.

• Equipment is normally sold unencumbered, but occasionally the finance arrangements may be assigned to the buyer with the consent of the financier. It may be attractive to the buyer to do this depending on the term of the loans and how mature the loans are. A loan where the interest is calculated on the ‘rule of 78’ may favour buyers taking on these loans.

• Purchasers may also seek to acquire the existing trade debtors if part of their funding facility includes debtor finance, because to qualify, the buyer must hold title to the assets against which the finance is secured.

• If the assets to be sold are held by more than one entity, the seller may comprise a number of entities which can usually all be listed in one single sale agreement.

• As the business’ legal entity is not being transferred, tax losses are not transferable to the purchaser.

• Asset sales are subject to Stamp Duty in some Australian States, and may also attract GST. Both will need to be considered and factored into the overall transaction.
• Asset sales generally pose a lower tax and liability risk to the purchaser as the legal entities, along with all associated encumbrances (both known and unknown at the time of settlement), remain with the seller.

Share Sale

Under a Share sale, Shares in the legal entity/entities holding the business assets are transferred to the purchaser on settlement. This may involve the sale of the shares in the trading entity, related entities and occasionally units of a unit trust.

• It may be easier to sell the shares than re-assign or novate large numbers of contracts or licences.

• Even where shares are sold, the existing business loans are usually paid out at or before settlement.

• Share transactions are usually more complex and require more sophistication all round. In general, there are more ‘moving parts’ to a share purchase agreement.

• In some instances, where there are multiple vendor entities, included assets may need to be transferred in or sold separately, and other assets transferred out. These preparatory transactions may result in stamp duty being payable by the seller’s entities before the ultimate sale to the buyer.

• There may be more flexibility to structure the transaction to optimise the after-tax outcome for the seller.

• There may be franking credits or tax losses to consider and to forego, use or transfer to the buyer.

• There may be future tax liabilities resulting from the adoption of tax effect accounting. These may need to be negated by the parties agreeing not to adopt this particular accounting principle in the completion accounts.

• There is increased risk to the buyer due to acquiring additional contingent liabilities from the past.

• Stamp duty is generally not payable on share transactions, which may make it more attractive to acquire the shares in States where stamp duty is applicable to Asset Sale transactions. If the shares are being acquired in an ‘asset rich’ company, stamp duty may still be payable on the tangible asset component.

• As ownership of a legal entity is being transferred to the purchaser, share acquisition transactions require more extensive Due Diligence (DD) to detect any potential liabilities attached to the transferring entities. In particular, Tax and Legal DD are areas of particular concern. This leads to greater transaction costs for the buyer.

• More stringent requirement for the entity to be ‘cleaned up’ before being handed over, eg. all issues need to be scrutinised and rectified or provided for before the company is handed over. These may include unpaid FBT liabilities, Payroll tax and restructure costs. It may even become more costly to clean these up than sell the assets and later liquidate the entity.

• If the seller requires it to be a share sale transaction, they and their advisers should undertake a more comprehensive vendor DD review prior to going to market to ensure the entity is ‘clean’ so there are no hold-ups or show-stoppers later.

• More extensive warranties are required of sellers by the purchasers to overcome the increased risk from transfer of a legal entity.
• Where the shares are to be sold, allowance needs to be made for income tax for previous years’ and the current YTD’s trading, just as it would be payable by the seller if they had retained the entity.

Determining the optimum transaction structure for you can be a complex process. It is important to liaise with tax and legal advisors early on to determine the optimum transaction structure from both the purchaser’s and seller’s positions. In many cases, there are pro’s and con’s and no clear cut advantage either way.

Although Divest Merge Acquire’s team includes qualified accountants, we do not provide specialist tax, legal or accounting advice to clients or anyone else. We have sufficient knowledge to recommend to our clients that they seek appropriate advice and usually lead negotiations through to resolution of the various components.

When large transaction values are involved, it makes sense to obtain a second opinion from a tax specialist, in the same way as you would consult a medical specialist and even obtain a second opinion about a significant medical condition.

Where applicable, Divest Merge Acquire can refer clients and their advisors to specialist tax or legal advisors to ensure the seller’s team is equal in sophistication to that of the buyer.

Australia’s ageing population has consequences for business, and succession planning is fast becoming a major issue. Deciding on the best strategy for exit is crucial for would-be retirees to maximise proceeds on sale, and ensure a smooth transition to retirement.

Many in this situation do not know where to look for advice when starting this process. This article provides an overview of each of the exit strategies available, and is designed to be a springboard into detailed planning with your accountant/advisor.

The point of retirement for business owners is generally when they value their leisure time over making more money. The desire to exit may prompted by age, ill health, other pursuits, a long holiday, a change of career, the attraction of a new challenge, or simply that it is no longer a core business.

Owners usually want to hand the business over to those whom they believe will succeed. This may be because of loyalty to staff, to secure a long-term tenant for their freehold property, or just the desire to see the business continue indefinitely.

The business may be their baby, one that has been part of their family, providing their lifestyle, friends, social network, their passion, their way of living out their dreams, or simply an investment. Whatever it has been, they now want something else more.

This can be an emotional time for business owners. The letting go, an uncertain future, parting company with friends, leaving behind a way of life and handing over custodianship of their business.

Ways to Exit

The alternative ways to step off the treadmill are:

1. Succession of Ownership – to children or other family members
2. Succession of Ownership – partial or total Management Buy Out (MBO)
3. Capital raising / IPO – for those businesses large enough to withstand the cost and due diligence process
4. Merger with others
5. Sell as a going concern
6. Close and liquidate assets

Appeal of different exit strategies

This is how business owners say they would like to exit:

• 60%:  Sell to a third party
• 30%:  Family Succession
• 10%:  Sell to management or staff

This excludes the ‘close and liquidate’ option which is more likely to apply only to smaller businesses.

The flowchart below illustrates the various exit options available to Retiring Business Owners, to be discussed in further detail in this article:

Succession Plan

It takes careful planning and thought to achieve a graceful exit from your business, especially to someone you know.

The succession plan outlines how the critical roles in the business will be filled in the future. Before you can develop a succession plan, you need to know where your business is now, and where you would think it will be in the future.

The succession plan should deal with two main components, ownership succession and management succession:

1. Ownership succession – Transfer of assets – transferring the wealth in the business to the designated successors.
2. Management succession – Transfer of power – management and control of the business is transferred to the chosen successor. This is appropriate when the owners want to retain ownership but reduce or relinquish their role in its management.

In a sale to a third party, both are transferred together.

Ownership Succession

Because most owners expect the proceeds from sale to be important part of their retirement funds, they cannot afford to give away their businesses to their children.

Whether or not the owner is transferring the business to family members, they usually want the value they deserve out of the business selling. A professional valuation is needed even if selling to family members. Your accountant can usually arrange this.

Steps for a Smooth Succession to Family Members

Where the owner chooses to take no further part in the business, and transfers both ownership and control to his or her family, there are a number of considerations:

• Seek outside professional help –  to navigate through the emotion that surrounds the process. An objective adviser can help resolve disputes and ensure that the decisions made are the best for both the family and the business.

• Hold a family retreat – a structured meeting with one or more generations, including spouses, after the concerns, wishes and aspirations have been identified from a one-to-one interview process.

• Write a Constitution – a document, prepared by your lawyer, that sets out the agreement between generations on a wide range of matters.

• Build in flexibility – The plan needs to be flexible enough to be changed if circumstances change.

• Family – The owner may want leave the business to the children in equal shares to avoid favouritism. But in most cases the children don’t work well together and arguments damage the business.

• Consider the Structure – Select an appropriate legal structure. For example, forming a family trust to own and operate the business may provide tax and other advantages, especially where the owner wants to gift the business to the children, but still run it through the trust.

It is important to provide for the ongoing, capable management of the business. It is imperative to place active ownership in the hands of those interested and capable of providing future direction, input and support to it. Multiple classes of shares and shareholder agreements can be used to match the specific objectives of family members with their rights to ownership prerogatives.

Some specific techniques which can be employed include:

1. Separating ownership from management interests.
   If the business is a company, different classes of shares can be issued to children not in the business which entitle them to dividends but not voting rights.
2.  Directing or restricting subsequent share transactions.
   The succession plan can include provision to deal with a family members’ desire to sell their shares. Specification of the mandatory buy-out of the shareholders’ interests, either through redemption or requirement to sell the shares, is a standard approach to handling this type of situation.
3. Limiting outside investors’ purchase of shares.
   By using an agreement giving the family or company the right of first refusal before any shares can be sold, the business owner can reduce the opportunities for outside investors to purchase an interest in the company.

Management Succession

If a business owner wants to retire, but does not want to relinquish ownership of the business, he or she might appoint a family member, partner or manager to run the business. This has the advantage of continued involvement without the responsibility of dealing with the day-to-day running the business.

The options available in terms of selecting a manager for the business include:

• Choose a family member;

• Select a key employee;

• Form a committee of family members; or

• Bring in a manager from outside the business.

Considerations include:

• Letting go of the steering wheel. The owner must accept that he or she no longer controls the business. Handing over the reins can be the most difficult decision that an individual has to make in professional life. Many owners find it difficult to step back from a business that they have nurtured over the years and leave decisions to others. If they fail to step back, then they are not really retiring and the intending manager may become dissatisfied and frustrated.

• Determine the factors that are most essential to managing the company in an effective and efficient manner to facilitate continuing growth and development.

• Expectations and capabilities of senior executives.

• Have a clear timetable for succession. If you plan a phased approach, it is important both the incumbent and the successor are comfortable.

• Start early – Well thought out succession plans take time to develop and implement. If the change of control is to be successful and the business is to continue to prosper, it is essential to effectively plan and properly assess the situation. The replacement manager should be progressively trained and assume responsibility as they prove themselves.

• Qualification – qualifications and abilities of family members. Taking over the business by children should not be a right, but should be earned. The successor needs to qualify with appropriate experience. Assess whether family members have both the aptitude and interest necessary for running the company. Many parents find it difficult to properly assess their children’s management capabilities. A professional appraisal of both the existing and potential capabilities of the children should be carried out. This will benefit both the children, who should not be made responsible for something which is beyond their capabilities, and the parent, who may still be relying on income from a successful business.

• A Board – Set up a Board of Directors of suitably qualified non-family members. Provided the family members take advice from the Board, the business should be strengthened and many family arguments may be avoided.

• Continuing liability. If the owner continues as a partner or director he or she may become personally liable for debts incurred by the business, even if he or she had no knowledge of the debts.

• If more than one family member wants to take over, consider how the takeover should be organised and how the family members will work together.

Family Succession in Perspective

Only a small number of family businesses are actually sold or transferred to family members:

• 70% are either sold or closed after the retirement of the founder

• 30% are passed on to the second generation; and just

• 10% make the third generation

These low succession results point to the need for those who want to transfer to family members to plan early.

• 40% of owners have children they believe are capable of taking over the business.

• Only 20% believe their children are both willing and able to take the business over.

• If not sold outright, most owners prefer to retain some control and/or income from the business.

Fewer than 40% of business owners have succession plans. If family succession is intended, find out early if the children want this. Many more owners expect their children to take over than actually do. Most children want to make their own tracks in the snow.

Succession to Staff or Partners

Succession can also mean the sale of the business to loyal employees or to others who have worked with the owner for many years and whom the owners would like to give first choice of taking the business over.

Appointing a Manager

This allows the owner to retire from the running of the business without transferring ownership. It can be a useful interim step, provided safeguards are in place. Having a stable manager in place will usually make it easier to sell the business at a later stage.

Some of the issues associated with appointing a manager are similar to those found in leaving family members or partners to run a business. Care must be taken in setting the manager’s remuneration, level of autonomy and reporting responsibilities.

It may be necessary to offer the manager equity in the business as a personal stake in its success. This may be particularly important if it is intended to pass the ownership of the business to children with a manager in place. The children may not have the knowledge or interest to ensure that the manager is honest and is doing a good job. If the children have some aptitude for business but lack the time or interest to run it themselves, a mandate should be clearly established. Such an arrangement should recognise both the manager’s responsibility for day-to-day operation without interference and the family’s right to make policy decisions.

Where the owner has relinquished management but not ownership and the owner later decides to sell the business, he or she may not receive the same price as while still personally involved.

Conversely, some businesses thrive under new management and significantly increase in value. Either way, there is additional risk that needs to be taken into account.

Management Buy Out (MBO)

A Management Buy-Out is the purchase of a business by its management, usually in conjunction with an outside financier. Private equity MBO financing is where a business is purchased by its management team with the assistance of a private equity fund.

Buy-Outs vary in size, scope and complexity. The key feature is that the manager acquires an equity interest in the business, sometimes a controlling stake, for a relatively modest personal investment. The existing owner normally sells most or all of their investment to the manager and the financiers as co-investors.

This may be an option where the business has a management structure that can carry on the business without the owner and the MBO team has the financial capacity to structure the MBO funding.

Management Buy-Outs have a good success rate and can typically achieve significant returns for the owner/vendor.

Management Buy-Ins (MBI)

Management Buy-Ins occur when an external management team, usually in conjunction with outside financiers, purchases a business they do not currently run.

MBI teams can provide the key to unlocking a transaction for a vendor. Sometimes owners are keen to sell their businesses but don’t have the management teams willing or able to take the business forward.

Key success factors include:

• Strong experienced management team

• Commercial viability of the business

• Structure of the transaction

• Cash flows of the business

• Willingness of Vendor

Businesses tapping the private equity market often do not have sufficient collateral or a track record of profits to obtain bank finance.

The investment horizon for a private equity investor is usually between five to ten years. Exits are normally achieved by listing on the stock exchange through an initial public offering (IPO) or by the sale of the business.

While many private equity funds take a controlling stake, they can provide management advice and specific performance targets.

Buying the business you already run from a parent company or existing shareholder is an increasingly viable option with rewarding results for management. However, choosing the right financial partner to back you in this process is essential.

Part Sale to a Passive Equity Partner

There is plenty of money available for investment in good businesses. What is in short supply are people capable of running them.

The equity partner will be comforted by having the owner stay on to run the business. This may suit owners who want to unlock some of the capital invested in the business whilst maintaining an interest and an ongoing income stream.

Both parties must have an exit strategy. This may be by way of ultimate sale to a third party or the equity partner installing a manager before the owner retires.

An equity partnership may also be appropriate when some of the partners in a business are retiring and others want to stay on but can’t afford to buy the exiting partners’ shares.

Part Sale to an active Equity Partner 

This involves the new partner assuming responsibility for the operation, with the original owner retaining a financial stake and involvement in the operation for a period of time, coinciding with the retention of part equity. There needs to be a phase out over an agreed period.

This may suit situations where:

• The owner wants to ‘pre-sell’ the business in preparation for ultimate retirement.

• The owner wants to maintain an interest in the day-to-day activities and the future success of the business.

• The incoming owner wants this additional security on handover to ensure a smooth transfer of the goodwill of the business.

Merger with a similar business

A merger is when two companies agree to go forward as a single operation rather than as separate entities.

The idea of the merger is that the owners or CEO’s agree that by merging they should both benefit more than by continuing alone.

Companies seek out other companies to see if the combination of the two will create a more competitive, cost efficient operation than either one currently is. The two companies should hold a bigger market share and achieve greater efficiencies through such a deal. A merger may also be advantageous to the organisations that are unable to survive independently.

Mergers may be driven by the need to create an organisation large enough to support a stronger management team than the separate organisations can justify. This may allow the respective owners to retire from the operation and achieve management succession. It may also set up a subsequent transfer of ownership through sale or MBO.

Some benefits come through from efficiency gains resulting from combining administration and other similar functions. There should also be better cost efficiencies and the combined group will end up with a much higher profile in the industry, which gives more confidence to those with whom the new operation deals.

A merger does not necessarily involve equals. If one company is much larger or smaller than the other a merger can still work.

Sell Outright

This is by far the most common way for owners to exit their business. With early baby boomers now retiring from their businesses, and with their children off doing other things in most cases, their only real exit strategy is to sell.

After the business is sold, the owner no longer needs to worry about it and this can be a great relief in retirement.

This strategy provides for the sale to the broader market of prospective purchasers. It also means the owner can negotiate a sale price through a competitive process without worrying about agreeing a price with family members.

The sale is often referred to as “The Big Transaction”, as it may be the single most important business transaction for the owner. It is essential to plan early, get the best possible advice and then proceed to the market with a clear understanding of how much you are likely to realise from the sale after tax.

When a business is sold on retirement the proceeds can be safely invested in a way that will ensure a sustained income for the remainder of the owner’s life.

One complicating factor in selling the business is that it may be difficult to sell without the involvement of the owner. For example, if there is no professional management in the business, the purchaser will be likely to want the former owner to stay on and operate the business for an agreed period of time.

Key rules when proposing a sale:

• Make sure the business is ‘sale ready’.

• Obtain a Business Valuation.

• Have an Information Memorandum professionally prepared.

• Make sure the business is properly marketed.

• Don’t try to negotiate the sale yourself.

Where to get help

Accountants are the most common source of professional advice for succession planning. Many Accountants have an excellent understanding of their clients’ businesses and are a logical first port-of-call when considering a possible sale, providing the platform from which other specialised services are sourced.

The family itself is a common source of help for many business owners.

Business Sale and M&A (Mergers and Acquisitions) Consultants/Advisors, such as Divest Merge Acquire, are often called on for involvement in the early stages of the planning process to coordinate an exit plan with you and your Accountant, and assist in preparing the business for an optimal exit.

Once you’ve decided to sell and initiate the sale process, one early dilemma you may face is who should you tell? ….And when? ….And what should you say?

In a nutshell, you want the business sold but don’t want anyone to know it’s for sale (except for just the actual purchaser!). This ideal breaks down when we want to create a competitive process.

There are circumstances when it may be attractive for owners to offer the business for sale to one purchaser only. For the majority of situations, below is the advice we regularly offer.

First consider and rationalise the risks. Who can hurt you? Typically the risk areas are staff and customers. Eg. customers may leave you, staff may leave you and competitors may be predators poised to seize both!

Although such concerns may be well founded, in many cases owners can become paranoid about these risks. Generally, the more hands-on the owner is, the more risk there is when a change is proposed. So, first assess and rationalise the risks involved. As Mark Twain once said:

“I am an old man and have known a great many troubles… but most of them never happened”.

Often the actual risks are minimal and the real issue is the owner coming to terms with selling. Some owners don’t want to believe they are actually selling, because it creates too many unknowns or issues. Not telling anyone allows them to shut it out of their minds and forget they are actually doing it.

Our advice: There is nothing wrong with selling your business! Every successful business person will do it some day.

The biggest concern is that someone who trusts you might find out from others. This could place you on the back foot and make you wish you had told them earlier. Although Confidentiality Agreements are signed by prospective purchasers, you must assume they are of no value and that prevention is the best cure, just as with safety. DMA adopts this approach to confidentiality, which is why we offer to pass every respondent’s details by our clients for approval before they can receive an Information Memorandum.

Even if you don’t tell your staff, they may know or find out anyway; and usually from the owner. 90% of communication is non-verbal, so you never have to say anything to actually tell them!

We often come across situations where the owners delude themselves that their team hasn’t been ‘officially told’, so it’s business as usual. They are half right. Generally, although their key staff know or strongly suspect, they generally play ball and continue on as though they did not know. However, if you haven’t been a model employer this is the time when your chickens may come home to roost.

Here is a menu of ways to tell your team and when:

• Tell no-one until the business is under contract; This may work, but generally astute staff would have cottoned on by now if you haven’t already told them one way or another; Purchasers often ask if staff know and feel more comfortable if they do know and are still there;

• Tell no-one until the sale is under way and purchasers are in motion; Even then, you may not want inspections during working hours, so as not to distract your team from their work;

• Tell only your key people. They will become instrumental in the sale process anyway, as new owners will need to know who is staying and establish a mutual degree of comfort. They may also become key attractions to purchasers, which assists bringing the process forward;

• Tell them early and tell them everything; Go outright, run it up the flagpole; tell your team and all your customers you are retiring/leaving. If you are past normal retirement age, they will have expected this, be genuinely happy for you and offer to assist you and the new owners;

• Advise them you are seeking external investors to take the business to the next level. This reassures them you will be around after settlement and the business will not fall out from under them overnight. In reality, Owners will generally be involved with the business for a retention/handover period after settlement, and in some cases elect to retain a small interest in the business.

• De-sensitise timing: tell them you are interested in phasing yourself out and will start looking for investors, and that this could take a long time and that you do not plan to go anywhere in the short term; Meanwhile, we will work feverishly in the background to make it happen as quickly as possible;

• Emphasise the positives: In many cases a change of ownership provides an opportunity for staff to move into blue sky, with a larger organisation with expanded career opportunities and scope to move  around; Promotion is often on the cards for your managers; A new corporate owner with greater financial capacity, growth plans and expertise in other fields often creates much excitement throughout businesses which had been held back by owners in retirement or sell mode;

• Many clients believe that their industry is the worst, that their competitors are far more nosey, predatorial and prone to gossip than in any other industry. In truth, all are about the same, as they all contain people.

Unless told otherwise, Divest Merge Acquire assumes the sale process is highly confidential and that no-one knows.