It’s a special day when an entrepreneur achieves their lifelong dream: transitioning to the next phase in life by making a financially-beneficial exit from their company. For most, achieving that goal will take a great deal of hard work and business succession planning. While we’re conditioned by media reports to believe that billion-dollar business sales are the norm—think tech-sector acquisitions as a prime example—those are the exception to the rule. In most cases, business succession strategies take years to conceive and implement.
As we noted in a previous blog in this series, business succession can be a complex affair. Deciding on a successor—whether from within your family, your company or by recruiting outside talent—is never easy. Simply developing a succession strategy is challenging enough, often because entrepreneurs don’t know where to start. Then there’s the process of positioning the business to sell.
Parallels between real estate and succession planning
The eventual sale price for your business could have a major impact on how your future entrepreneurial endeavours or next steps in life play out. Most owner-operators are particularly concerned about funding their retirement after having spent years (in some cases decades) building a business in the hope of one day cashing out.
In most cases, entrepreneurs will sell their business to their employees or children—often transferring shares to family, which is now far more beneficial from a tax perspective thanks to tax law changes introduced with Bill C-208—or will sell to an external buyer.
All three succession strategies come with clear challenges, but it’s the latter that tends to test business owners’ patience and strategic abilities. Selling your business is like selling a house. Finding the right potential buyer—or multiple interested parties—means properly marketing and staging the property to make it as attractive as possible to the marketplace. It takes an effective approach and savvy negotiating to maximize your sale price. And that’s not all.
Valuation: Your sweat equity doesn’t matter
So, you’ve been toiling away, working 14-hour days for 30 years to achieve your entrepreneurial dreams. Congratulations, but your prospective buyers don’t care. They’re interested in what the business is worth now and in the future. Wrapping emotion into the valuation process—and make no mistake, properly valuing a business is also highly complex—is a common pitfall that traps many business owners, clouding their sale price expectations. Work with a specialized valuation expert and your accounting team to determine a realistic value for the business.
That number will be influenced by everything from intellectual property and capital assets to long-term revenue potential, your client list and the health of your current balance sheet. Remember that what matters is what the market will pay, not what you think the business is worth.
Play the long game
Many business owners think about succession as they prepare to exit the business. But planning should begin years—perhaps even a decade or more—before you plan to ride off into the entrepreneurial sunset. A long-term strategy will inform everything from your approach to mergers and acquisitions to personnel moves in the lead up to an exit.
The goal is to develop a plan that helps grow the value of the business over time. Ideally, your buyer(s) should look at your books and be blown away by the opportunity to acquire your company. They should never have doubts, or be able to deliver a lowball offer based on a depressed valuation of the business (valuation is typically determined by calculating a multiple of a company’s earnings before interest, tax, depreciation and amortization, or EBITDA). Maximizing profitability, building as much brand equity as possible and developing indispensable products or services that you deliver to an impressive client list, are just some of the long-term goals that should be on your radar.
Put your personal finances first
For the vast majority of business owner-operators, their company is their main source of wealth, both during their working years and in retirement. Your business succession strategy should take into account the eventual income you hope to generate in retirement from your wealth portfolio, which will be funded at least in part by the sale of your business. Do you hope to travel, give money to your children or maybe become a philanthropist? All options are on the table—and they all require ample income or assets.
One of the most important personal financial considerations is on the tax side. Proper business and estate structuring will help to minimize your tax liabilities when the business sells, as well as when you draw income from your investment portfolio. Build your financial plan with the assistance of a qualified advisory team—such as tax lawyers and accountants, along with your financial or wealth planner—and have an advisor who can quarterback the strategy aspect of the discussion on your behalf. Many professional service providers are silo’ed in the way they deliver their tactical advice. You’ll need a member of that team with the right skills and experience to look at the bigger financial picture.
Upgrade systems and processes—and get your books in order
Buyers want to see stability and replicable operational practices. That means developing systems to ensure that each of your business activities can be taught and duplicated with relative ease. Most larger organizations will have these processes in place, but a surprising number still rely on antiquated practices that are a red flag during the merger or acquisition due diligence process.
That includes financial record-keeping. While larger firms don’t rely on so-called ‘shoebox accounting,’ many SMEs need help getting their books in order to present to potential buyers (or investors, for that matter). That could mean hiring an experienced CFO to help clean up those records and position the company in a more favourable financial light.
Manage the timing and transition
Selling in a down market is never a good idea. Many organizations had a field day gobbling up distressed businesses or assets during the COVID-19 crisis, often at a fraction of their pre-pandemic valuation. Timing your sale during better economic periods, or when the company’s revenue is peaking, will help maximize an eventual sale price.
Last point: the more leverage you have, the better you can manage your transition out of the business. Some purchase deals involve a straight cash or share exchange, but many at the small to medium-sized level involve some form of earn-out—a situation where a business owner continues to operate the business for months or years after it’s acquired, but must achieve certain (often lofty) financial targets before they earn the full sale price. Needless to say, contractual earn-out agreements present a minefield of potential challenges.
The better position the company is in, the easier it is to set the terms of your succession. Even when passing the business on to children or selling to employees, it’s possible to wind down your involvement or even maintain a stake in the business in perpetuity to stay engaged and draw an income well into retirement.
After all, you’ve spent the bulk of your life building a company and doing it your way. The exit stage is no time to let anyone else dictate your financial fortunes.
The Bridgewell Team