Passing the Torch: Comparing the Types of Business Successors
Who is best suited to continue the legacy of your business?
As a business owner, you understand the importance of planning ahead. Every business requires accurate forecasting, budgets, hiring schedules, and marketing campaigns to be successful but what most business owners do not have is an exit strategy. Nearly 90% of business owners are unsure of what to do with their business at the end of its life span. We’ve heard everything from just shutting the company down to handing it over to children who may not be interested in carrying on the legacy. After all of the years you spent building and growing your business, you deserve to cash in on your hard work and sweat equity and this can be done through proper exit strategy planning.
The first step to planning a rewarding exit strategy is to know your options, and believe it or not, you have more options than you think. Business owners are often uncertain with how to transition the business to a new owner, which can result in under-pricing the business or a messy sale. Identifying the right type of successor for your business starts long before you are ready to sell and we recommend meeting with a professional business broker around 18 months prior to when you would like to transition out of the business. In our experience, there are four main types of succession options for middle market business owners: family members, employees, co-owners, and third-party buyers. To help you come to the conclusion of what is best for you and your business, we have laid out the pros and cons of each type of successor, along with notes to consider before deciding the right path for your business.
Pros: Stays in the family, supports family members, industry familiarity, owner still available.
Cons: Issues in splitting the business, intensify family dynamics, lack of interest, potential inadequacy.
Passing your business down to a family member can be a very good option for some business owners, but it does not come without its cons. 30% of all small businesses are successfully passed on to the next generation. If you inherited a business founded by your parents, it is natural to want to watch your children continue the legacy. Unfortunately, not every child wants to follow in the footsteps of their parents and some may not be prepared for the responsibility of running a business. Our advice on identifying a relative as your successor is this: make sure they want to manage the business. If the family member has no interest and you simply want to stay half-way involved and watch them grow the company, it will not be successful. If you family member does want to inherit the business, there are still many challenges to overcome such as obtaining capital or splitting the business among several siblings.
Pros: Vested interest in success, industry knowledge, smooth transition, employee stability.
Cons: Difficulty in securing funding, lack of access to capital, employee dynamics.
Co-owners are another viable succession option for owners who may not want to pass the business on to their heirs. Upper level managers have the experience, knowledge and skill to run the business while understanding the unique culture within. They also know the employees and their roles, creating more security in the minds of your staff. The biggest roadblock to selling to a manager is securing funding; oftentimes, managers have issues with access to capital which may result in seller financing or a seller note.
Pros: Key employees understand the business, faster sale.
Cons: Employees may lack necessary experience, negative employee dynamics, seller financing.
Like managers, business owners sometimes opt to sell the business to one or two key employees that have an interest in taking over. While identifying a key employee can lead to a faster transaction and a closer closing date, we suggest thinking long and hard about this succession strategy. While key employees may harbor the ambition and drive to manage the business, they may not have the experience or the knowledge. Electing an employee as the new owner could potentially create rifts in the business among other employees and hurt the culture. Finally, employees might also have a difficult time securing funding, leaving you in a position where you may need to finance the sale.
Pros: Willing to pay more, large buyer pool, experience in M&A, management skills.
Cons: Uncertainty for employees, non-compete agreements, loss of identity for owner.
In our experience, third-party buyers provide the best outcome for business owners looking to sell their business. While other succession options may work best for certain people, third-party buyers remove the emotional aspects of selling and give the seller a clean break from the business. Third party buyers often offer benefits to sellers such as experience, skills, ability to pay a higher sales price and there are simply more of them, creating unlimited options for the seller. The downside to third-party buyers is that sometimes owners feel a loss of identity, especially when selling to a Private Equity Group. We truly believe third-party buyers are the best option for a majority of business owners, with an M&A intermediary on your side, the deal will work out to be more favorable for you than in other scenarios.
Identifying the right types of successor to your business can be challenging, but it is the first step to creating a successful exit strategy. Whether you are passing the business onto an heir or marketing the business to a third-party buyer network, having a plan is critical. It’s never too soon to begin planning for your future and the future of your business and with the help of an experienced business broker, the sky is the limit. We have helped thousands of business owners strategize their exit and we can help you too – call Viking today to learn about your options for exiting your business.