Starting and running a business is a complex venture that comes with many daily challenges. But, long-term planning to ensure a smooth transition out of a business is an even greater challenge, one that is often ignored until it is too late. Some entrepreneurs start out with the assumption they are going to sell their company within a few years, but this usually does not happen, and unfortunately, most business owners do not have an end-game. The most common reasons entrepreneurs and business owners lack of long-term planning are: (i) fear of failing in the short-term; (ii) day-to-day operations keep them busy, preventing them from focusing on their long-term goals; (iii) they do not have a clear idea of what to do with their business, specifically whether to sell to management, employees, or a third-party, or pass it on to their children.
Having an exit strategy is the best way to maximize the sustainability and best return for a lifelong investment, especially when it may be the last move for a business owner before retirement. Preparing a comprehensive Business Succession Plan will allow the business owner to plan ahead and maximize his or her gain.
Preparing an effective Business Succession Plan
The first step in creating an effective Business Succession Plan is to identify the best way to transfer ownership of the business. A series of legal, logistical, estate tax and financial planning will be necessary. The four most common ways to transfer ownership of a business are: (a) Passing ownership interest to family members; (b) Selling the business to a key employee; (c) Selling the business to co-owner or partner; (d) Selling the business to an outside buyer.
Considerations in determining the best way to transfer ownership of a business are numerous, and will vary depending on the industry, the complexity of the business, and the owner’s family situation and control ambitions. Sometimes, a business can be sold quickly to an outside party, sometimes the managerial and logistical transition can take a few years, and in some cases, planning and executing the passing of a business to family members can take dozens of years (For a great example of family succession, look up Amancio Ortega Gaona, the richest man in Europe and founder of Inditex, the world’s largest clothing retailer).
Whether selling the company in the short or long-term or passing it along to family members, once the best exit strategy has been selected the next step is to prepare the business for the execution of the strategy. Several basic steps should be taken to ensure that the business is ready: (i) Getting your advisory team in place; (ii) Getting a business valuation to obtain a realistic idea of what the business is worth; (iii) Getting the books in order to make due diligence easier for a buyer; (iv) Protecting intellectual property and other essential assets to ensure the profitability of the business for the successor; (v) Reducing operating liabilities to protect the business from unexpected downfalls (vi) Organizing all legal paperwork, including making sure all corporate documents, permits, licensing agreements, leases, contracts, etc., are current and in order.
Practical tips for a successful transaction
Once the exit strategy is clear and ready for execution, the next step is structuring the deal. A good succession plan must include participation by accountants, attorneys, tax and financial advisors, management consultants, among others. For instance, any family business succession process shall include all-inclusive tax and estate planning, succession strategy and transition planning. On the other hand, selling to a co-owner or partner will require a comprehensive entity-purchase and buy/sell agreement, selling to a key employee will require a compound Management Buyout (MBO) or Employee Buyout (EBO) agreement, while an Employee Stock Ownership Plan (ESOP) might be appropriate to facilitate employee ownership of the company. Furthermore, selling to an outside buyer brings different and complex ways to structure the deal: partial or substantial assets purchase agreements, equity purchase agreements, triangular or reverse triangular mergers, divestitures, etc.
In addition to the all above-mentioned, the process of transferring a business involves various legal risks. Therefore, it is fundamental to protect essential business information by binding all parties involved in the transaction to confidentiality agreements and/or non-disclosure agreements.
Finally, care will need in negotiating and drafting the final purchase agreement to ensure the proper drafting of key provisions such as: (i) Description of the transaction type; (ii) payment of purchase price, forms of considerations and price adjustment mechanisms; (iii) Representations and warranties; (iv) Covenants; (v) Closing conditions; (vi) Post-closing conditions, including earn-out provisions, royalties, equity interests, employment/consultant agreements; (vii) Indemnification; and (viii) Termination; among many others.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.