Putting the success into succession
Succession is arguably the most satisfying process for extracting monetary value from years of hard work in your business, but the key is to do it right.
In New Zealand many business owners look to exit their business every year; to extract some monetary value from decades of hard graft. Succession is arguably the most satisfying process for doing this, but the key is to do it right and allow plenty of time.
If you’re a business owner, it’s inevitable that one day you’ll want to say goodbye to your business for good, which could involve one of two scenarios: an exit (or sale) through natural succession in the normal lifecycle of a business, or one through forced circumstances.
The latter of these two exits can trigger distressing scenarios.
But here, we’re focusing on a better planned, more considered, exit strategy. One that has a much more satisfactory outcome.
It’s called succession, and it requires some serious planning.
Succession planning is a step-by-step process that cannot be rushed. Richard Cuthbert, senior associate at business advisory Management Response Ltd, and a mentor with Business Mentors New Zealand (BMNZ), says there is much to consider.
For example, is the particular market buoyant and sustainable? Are client relationships long-lasting and does the company have a great reputation?
If the owner is also ‘the business’ then a successor or buyer must weigh up the business’s value without his or her contribution.
Other considerations include any potential management gaps. Can these be filled?
Are the business’s processes and procedures fit for purpose? Will the departing owner mean that other loyal staff or family members also depart?
The successor or buyer must also examine the business structure, says Richard. That structure should separate governance (where the emphasis is on the long-term interests of the shareholders and strategic planning) from management (which places emphasis on the short term, day-to-day operations).
“Owners need to plan to make their business ‘sale-ready’,” he says. “And that usually requires someone who is independent to see what’s needed. Someone who understands the business and the sector it operates in.”
Richard knows many business owners, particularly Baby Boomers, who’re ready to realise value from their long-held businesses. He doesn’t think Kiwis are particularly good at exiting their businesses, and we’re not unique in that respect.
“But why should they be? For most of them it’s the first, and only, time they’ll do it,” he says. “Most businesses are worth something to someone else, but perhaps no more than they are to the current owner. But owners should be able to reward themselves for all those years of hard work and risk-taking.”
What can possibly go wrong?
If you’re on the brink of deciding to exit your business, check out Richard’s ‘8 biggest succession mistakes owners make’ (see sidebox), and then seek some expert advice, because a lot can go wrong.
Just as the British Royal Family (aka ‘The Firm’) passes on the mantle to the next-in-line, business owners too usually look to the next generation of people in their business, or sometimes family members, and desperately want them to take the business on, explains Richard.
“This gives the owner a legacy, and those buying in a chance of ownership, control and potentially increased wealth. The new owners are people, ideally in their 30s to 40s, with great experience, key client relationships, and the drive and energy not just to maintain the business but take the company to the next level.
“But they are also building their own lives, with young families, mortgages and limited disposable income. They often have limited experience of ownership, and what that entails, or little understanding of balance sheets, investment and profitability.
“I know some who think every bit of profit goes straight into the owner’s pocket every year,” he says. “They can also be people who are happy to take the upside, but have little appetite for risk or the idea that there are inevitably business cycles of up and down.”
When it all goes right
Richard has many successful business succession cases to draw upon for lessons and knowledge, including a large Australian multi-discipline engineering consultancy looking for a foothold in New Zealand.
An example of how flexible these arrangements can be is a medium-size engineering company which, to date, has had 35 percent of its shareholding sold to management.
“I was initially appointed to develop and improve the business, particularly its leadership and management,” he recalls. “A series of changes were implemented over a two-to-three-year period. Then the two founding directors couldn’t agree on succession plans. This led to a de-merger, spinning out 50 percent of the company into a new entity.
“The succession plan options for the remaining business included a sale and management buyout (MBO). An information memorandum was subsequently prepared, bids invited and a preferred bidder identified.
“However, the owner then decided to pull the sale. His preferred option was to protect the company culture and loyal staff through an MBO.
“So, the company was independently valued and the first tranche of shares offered to the management team at a small discount. Eleven staff accepted the offer and purchased 35 percent of the company shares, all using cash from their own resources, or borrowings.
“The second sale tranche is scheduled for July 2023 and the founding owner intends to retain a substantial, but minority, shareholding.”
That’s a lot of flexibility.
On a final note, if you’re unsure about the timing of your exit, Richard’s best advice is to talk to your peers. They’re likely on the same ultimate journey as you, although they will, of course, be dealing with different circumstances.
Most important of all, start early, he says.
“It’s never too soon to start planning for succession.”
CASE STUDY: Exit in the pipeline
Nick Morton is looking to exit his Te Awamutu-based business Pipeflow Technology. While he has yet to accomplish his objective, he has nevertheless learnt some useful lessons.
Nick Morton turns 70 in November. He’s ready to hand his pipeline maintenance and commissioning business, which he has been managing director of for the past 28 years, on to a worthy successor.
Naturally he’s looking for a successor younger than he is. It’s not that the business is overly physical, he says, it’s just that it’s more suited to a younger person.
Nick was first matched with Business Mentors New Zealand five years ago, to seek advice on quality control, and on consolidating his business to move it forward.
More recently, after attending one of their seminars, he was motivated enough to seek their assistance to help review his business and prepare it for sale.
The fact that BMNZ is not driven by income appealed to him. Unlike professional brokerage firms which often push for a sale which can favour the buyer, with BMNZ there’s no focus around getting a return for their organisation, he says.
“They’re genuinely interested in helping business owners achieve their goals, whatever they may be.”
Ideally the right purchaser will already have experience within the same industry, Nick says, and Pipeflow Technology will simply “add another string to their bow”.
“I particularly needed someone to estimate the current value of my business and its potential value in the hands of a future owner who can commit full time in it,” explains Nick. “There’s potential to double or even triple what the business is earning now.”
BMNZ put him in touch with New Plymouth-based mentor Peter Ertel who started his own business and successfully managed to exit himself before ultimately selling it. Peter has worked with many business owners to prepare their businesses for sale – the important thing being it needs to be a business and not just a job, and preparation is everything.
Peter and Nick get on well together and Peter was able to assist with valuing the business and, in Nick’s words, “to argue its final selling points”.
“Together we worked out a strategy for how we would present the business to potential buyers, both from a financial and business plan perspective,” says Nick. “A broad-brush approach.”
To date there have been a couple of ‘nibbles’, which were immediately emailed to Peter for vetting.
“The relationship works very well,” says Nick, adding that the next stage is throwing out a wider net to see what bigger fish are out there.
Meanwhile the door is still open to those nibbles.
A long runway
So, what advice does Nick have for other business owners seeking assistance with their business exit or succession plan?
“Start early, give yourself five years to get a result, otherwise you’re in danger of getting to a point where you’ll say ‘I can’t do this anymore’ and you’ll panic.
He says while it’s a case of sticking to your guns and chipping away at things, he has made up his mind that, at a particular date and whether the business is sold or not, he’ll draw that line in the sand and try a different exit strategy. No-one wants to spend a lifetime on your creation and end up simply closing the doors.
He hasn’t given up. Nick’s hoping that “his mental line in the sand” attitude will work in his favour, because Pipeflow Technology operates in a niche industry, and a buyer will benefit from the knowledge that’s in his head.
“Those other companies approached us because they saw the potential, and that potential is still there.”
As Nick points out, the sticking point with any business sale, or succession plan, is estimating the real value of the business’s potential. That’s where the most risk lies for both parties.
In his situation, there’s a strong probability of staying on as a consultant for the first year. With business undertaken project-by-project, learning is per project and the handover will be staged over time.
The 8 biggest succession mistakes owners make
According to Richard Cuthbert the most common mistakes he sees business owners making include:
- Not thinking about succession, or not letting go quickly enough.
- Picking the wrong people to succeed themselves.
- Not realising just how much of the business relies of them as long-term owners, often holding the majority of client relationships.
- Not separating governance from management.
- Insisting on passing the business to staff when sale to a third party might be quicker, easier and more beneficial for everyone.
- Assuming the business is worth more than it actually is.
- Allowing new shareholders to buy in without actually putting real skin in the game. Because of limited disposable income, they let new shareholders buy their way in by using future dividend streams – or by giving interest-free loans to buy shares. Both are bad moves for owners, although it happens all too often due to circumstances.
- Convincing themselves that the only alternative is to lock the doors one day and walk away (with nothing).