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by Dale Gillmore
We talk a lot about succession planning and with good reason: Most business owners are woefully unprepared for it. Part of that unpreparedness comes from focusing only on the mechanics of the deal -- the valuations, the tax loopholes, etc. -- and not enough time on the preparedness of the succession team to lead the company into the future.
I recently discussed eventual transition plans with a client who owns a small but highly profitable manufacturing business. He started the company on his own, ran it for 40 years, and plans to retire in the next ten years. Several years ago, his son entered the business and has since flourished in the company. He’s moving up the ranks quickly.
My client wanted to brainstorm on topics like appropriate payout, valuation, timing, and tax implications -- all critical considerations but insufficient when planning a successful transition. I suggested with think first about something else.
More important than valuation and taxes, at least initially, is to focus on making sure the transition is successful in the long term. This involves making sure that whoever you are handing over the reins to will be in a position to take over and effectively run the company. It seems obvious, but I routinely see more time and energy spent on the mechanics of the transition than making sure the people who are going to run the company have the skills and confidence to actually do it well.
We need not look further than the current attraction to ESOPs to illustrate this point. ESOPs are great for short-term tax solutions, but they too often fail in the long-term because the employees who overtake the organization aren’t properly prepared to do so.
In a dream world, you’d sell a business and receive 100% of the profits. This is rare and is especially so in an ESOP or when selling to family or employees. Most often the ESOP will pay a smaller percentage in cash at closing and then will pay a seller note or earnout over time based on the success of the company. In that case, or in the case of transitioning to a younger family member, there may be very little cash received at the time of the sale. When this occurs, the majority of the purchase price is paid for over a period of time from the company’s profits. And this, of course, is why the long-term success of the company is so important. You can hire the best legal and tax team available to work on the mechanics of the transition, but if you don’t educate and empower the new owners, the company will flounder and all the expected transition proceeds will never materialize.
In other words, the biggest risk in transition planning via employees, ESOPs, or family succession isn’t improper valuations or missed tax loopholes. It is the future success of the company since all or most of the buyout occurs after the sale is completed. This is why it is critical to spend time, energy, money, and resources doing whatever it takes to ensure your succession team is confident, skilled, and ready to take over and grow the company after you depart.
If you own a business and are starting (or wishing to improve) the process of transition planning, think about all the areas that are critical for the success of your business over the long term. Spend your time and resources here rather than the mechanics of the transition. Once your team is ready to take over, then you can shift your focus to the deal itself.
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by Dale Gillmore
A strong economy boosts CEO confidence and job production, but it also begs the question, “What’s next?” While the pace of economic recovery since 2008 is subject to debate, the fact is that we have been on a clear growth trajectory for years -- and a very strong one recently. By most measures -- a low unemployment rate, favorable interest rates, a strong stock market, and so on -- the U.S. economy is doing very well. But, if history tells us anything, it’s that, at some point, a downturn will come. It’s just a matter of when. The important question to answer, therefore, is how can we position our businesses to not only survive the tough times but thrive despite them?
Having successfully steered multiple businesses through several booms and downturns, we offer here our insights into how you can prepare your company today for a less robust economy in the future:
1. Utilize your sales channel to expand new products, services.
One of your most important assets is your sales channel and existing customers. Use that channel to expand during a recession by offering “adjacent” services to existing products (example: a warranty or free delivery service), extending services that might position the company for growth beyond the core business, and/or entering new markets through alliances, partnerships, mergers and acquisitions, or even franchising your product. In this way, you can grow the company without having to invest in new production facilities or inventory.
2. Carefully consider credit.
Most businesses have some form of a line of credit -- a loan on demand -- which can help with capital when the going gets tough. Currently, banks have more money than borrowers, so it’s a good time to consider increasing your line of credit and establishing new credit facilities “just in case.” Many companies go out of business during a recession because they run out of capital. Just be sure that, whatever you borrow, you can pay back. A recession is not the time to be scrambling to meet minimum payments.
Another strategy for increasing your cash flow during a downturn is through a change in credit terms from your vendors and to your customers. A change in how you pay suppliers -- from 30 days to 45 days, for example -- could make a big difference. Conversely, if your sales terms are overly generous, you will need to finance cash needs that could be met by better billing and collection practices. Lastly, determine if your suppliers are giving you their best deals.
3. Outsource what you can.
You already outsource more than you think: shipping of your products, your tax return, your insurance. You may even outsource some or all of your manufacturing overseas. In an economic downturn, a key strategy is to convert fixed costs to variable costs, and outsourcing is a great way to do it.
HR support functions, payroll, benefits administration, accounting, manufacturing, transportation, virtually all the non-strategic aspects of your company can be outsourced. Even your executive staff can be outsourced! Why pay a full-time CFO when a fractional CFO or one utilized through our firm can do the work at a cost well below the benefit?
4. Identify and create flexibility and liquidity with non-liquid assets.
During the last recession, virtually every U.S. car company except one, Ford, had to be bailed out by the government. Ford saw the recession coming and sold and leased back their facilities, creating a huge “rainy day fund” of capital that it later used to weather the recession. You could potentially do the same by reinvesting the capital tied up in your real estate into the production and growth side of your business (but please proceed with caution).
Review your personal and business assets to understand where your “creative” opportunities exist. Of course, you should consult with a seasoned advisor before proceeding with any option that affects your assets -- especially ones that have substantial equity.
We cannot pinpoint when a downturn will come, but history dictates that it eventually will. Prepare now for the eventual storm clouds of recession. We’re here to help.