Cheng-Chung Yu, MBA, CA, CPA, CFA, CFP
Published in 2013
The Need to Pass on the Baton
While a business can have a long-lasting life, the unfortunate reality is that business owners are all mortal. To an entrepreneur, a business is often like a darling child. It may be emotional when the time comes to bid farewell to this darling child. An entrepreneur starts a business from an idea, an innovation, a value proposition, a product supply, or professional know-how’s. Most businesses start from being small, nimble and humble. However, no matter how big, profitable or successful the business becomes, the business owner will inevitably come to a point to be in need of passing on the baton. A well planned and executed business succession is no different from the good planning and management of a well-run business. The better it is planned, structured and executed, the higher the value and the smoother the transition.
Today’s reality is that we are facing an aging population. Increasingly we see more and more businesses with owners nearing or even passing the normal retirement ages. Yet surveys show that an alarmingly low percentage of businesses with such succession needs are recognizing the need to plan out and execute the business succession well. A business cannot be run very well without a good business plan. Likewise, a successful business succession also requires a well-thought-out succession plan. Succession planning can also serve as an integral part of the business owner’s retirement and financial planning.
Why Planning
Business succession planning ensures that many important aspects of the business succession issues are addressed, including that:
- the business ownership is transitioning in an orderly fashion;
- the business succession meets the personal, business and environmental needs and objectives;
- the business owner can maximize value, minimize taxes and optimize the timing of the exit; and that
- the common pitfalls and failures during the business succession can be anticipated and avoided.
Exhibit I gives an overview of the business succession planning process. The process includes two stages: planning phase and execution phase. A properly planned and executed business succession can easily take at least a couple of years. Identification of the potential buyers of the business is obviously important. The buyers can be family members, existing management, financial investors, or strategic purchasers. Different types of buyers have different considerations, pros and cons.
Exhibit I: Overview of Business Succession Planning Process
Source: Business Succession Planning presentation to CFA Society Toronto by Chris Polson, Veracap, Mar. 26, 2012
Valuation is also an important task in the succession process. There are various valuation methods and approaches: asset valuation, sales multiple, P/E (price earnings) multiple, book value of shareholder equity, and discounted cash flow, to name a few. Discounted cash flow (DCF) is typically the more common and widely accepted valuation method. In any case, different valuation approaches can at best provide a valuation estimate or value range. In addition, the valuation result is still highly dependent on the accuracy and reasonableness of the various variables and assumptions put in. Valuations serve as the basis for the ensuing negotiations between the buyer and seller.
Some Case Studies
There should be plenty of live examples of people aging and retiring, and hence the many live cases of business succession when we look around our personal and working surroundings. As a chartered accountant and business advisor working with many business and personal clients, this author has also come across many real life business succession cases. Some were more successful than others. As mentioned, proper proactive succession planning increases the likelihood that the succession can be done without a hiccup and that the business itself continues to be a success.
After running a small accounting practice for many decades, an accountant I know recently sold his practice to another accountant located near his former practicing location. In addition to reaping a good business sale deal, the accountant has now become a consultant to the successor practice. He only works a few flexible hours a week to ensure smooth client transition and services, representing a sharp turn to an enjoyable semi-retirement life from his old stressful days. In a quite different situation, another accountant decided to move her family to the U.S. She did not sell her practice for anything. She continued to service her clients from her new California location for a year or two, while working on a new job she has in the U.S. The distance and the need for continued professional updates finally forced her to stop the remote work. Most of her clients would find their own ways to get a new accountant.
A book publisher successfully went through his second retirement at age 68. He had retired once previously from his professor job at the university. This side business from his teaching career took off nicely, employing about 10 staff. After going through careful buyer identifications and negotiations, one of his children took over the business, with the purchase price and payment and transition plans agreed to. This former publisher now frequents his family’s vacation property in Florida. He enjoys his free time and social activities with his families and friends. Sometimes he also helps out his youngest daughter, who started a new publishing house of her own. Another book publisher, however, might not be as lucky. He is 71 years old and still works hard every day. There is nothing wrong with his love and devotion to the business that he started forty years ago. However, if there are more serious thoughts and plans being directed to the business succession issue, many may agree that continuing to work hard on a full-time basis may not be the most ideal setup for an aged person.
Final Words
In a risk management seminar I attended, it was mentioned as an anecdote that an investment firm actually prospered from a disaster. The firm had an office in the Twin Towers of the World Trade Center that collapsed during 9/11. But apparently as part of the firm’s risk management and contingency plan, the firm had set up an offsite data backup centre. The firm was able to survive and become even more prosperous as it was one of the few that was able to minimize the disasters and disruptions and quickly resumed its normal business operations at that remote backup site. Planning does not always guarantee success. However, planning does help increase the likelihood of achieving success.
In today’s busy and fast-paced business world, there are always plenty of excuses for us to continue to drag our feet when it comes to succession planning. Yet time and time, and cases after cases again continue to give us the proof, power and the magic that a proper succession planning can do. It lays out the adequate time horizon to plan and execute. It forces the business owner to think and act ahead before it is too late. It maximizes the value, reduces the taxes, optimizes the transition, and ties succession planning into an integral part of the business owner’s retirement and financial planning. It increases the likelihood that a business succession is a success for all parties impacted. So, if you are nearing the retirement age, why don’t you put some serious thought and time to get onto the succession planning issue? Professional help and guidance are always available along the way to help you navigate through the process.