Succession Planning

The granddaddy of all succession plans

- John Mickelson, founder and managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

On November 8, U.S. citizens went to the polls and voted for who they believed should be the next President. President Obama, who is ending his second and constitutionally mandated final term, will hand over control of the executive branch of the government to President-Elect Trump on January 20.  

Wanting to escape from a monarchist system, our country’s forefathers’ setup this mandated transition of powers – which is just a big succession plan. This succession plan faces similar issues as you do as a business owner developing and executing a succession plan.

Here are some decisions that President Obama and President-Elect Trump may face, which are synonymous with what a seller and purchaser of a business might also face:

President Obama (Outgoing Business Owner)

·       Legacy – feel responsibility to have work done continued and reputation held in high regard.

·       Relationships – want to ensure loyal supporters are taken care of.

·       Future for family – want to make sure family is financially secure, safe, and well-adjusted to a new environment.

·       Time – figure out what hobbies, causes, and interests will occupy new found time.

President-Elect Trump (Purchaser of Business)

·       Strategy – what did predecessor do that should continue and what should change?

·       People – who should surround as trusted advisors?

·       Systems – need to setup procedures and protocols that fit the newly assembled team

·       Communication – clearly communicating a vision to different constituencies is important in first 100 days

If you are thinking about selling your business as part of a succession plan, a "transition team" just like President Obama and President-Elect Trump are using right now is vital to achieving your unique goals.

Are you partnership material?

John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Many a parent worries about their children finding the right spouse. Singles think about their wedding day, the ceremony and the flowers. Unfortunately, nearly 50 percent of marriages end up in divorce because many people do not think about what kind of married person they will be. Are they marriage material?

Many of those same qualities go into being a business partner. If you are thinking about partnering with someone on a business as part of your succession plan, you should structure carefully and think about your personality. Otherwise you may face the equivalent of a business divorce with your partner. Are you partner material?

Let’s look at some traditional marriage vows and overlay them with some hard-earned truths we have learned about partnerships:

I, Jane, take you, Joe, to be my husband,

Depending on the type of organization, the rights of each party (Jane and Joe) are spelled out in the bylaws or an operating agreement. 

to have and to hold

There is a strong likelihood that you will spend more time with your business partner than you will with your actual spouse.

from this day forward,

Most often business agreements are written to last from the date of signage until “forever” or until some predetermined event occurs.

for better, for worse,

Business partnerships ALL have their ups and downs. Regardless of which stage the business is in, you are in it with your partner. They will have ideas you may not agree with, and vice versa.

for richer, for poorer,

Strains in partnerships often appear when a business is very successful or very unsuccessful. Money (or lack thereof) can make partners (and their families) act differently than they have in the past. 

in sickness and in health,

Business partners get sick. Spouses get sick. Children get sick. Elderly parents get sick. Life happens, and we cannot always control it and it is no one’s fault. Partners should consider what options they have for the unpredictable events that will occur.

until we are parted by death.

Partners go into business with each other, not with each other’s spouses or children. As a result, business agreements should be written to protect the business – typically with a buy/sell agreement and key-man insurance – in the event of an untimely death of one of the partners.

This is my solemn vow.

It is not a vow, but contractual law forming a partnership is binding and requires a significant undertaking to unwind.

Finding a partner to purchase and run part of your business is a good option for a succession plan. There are no right answers to partnerships, and there are millions of examples of successful ones and as many examples of unsuccessful ones. A common thread on successful ones is clear communication, level-setting expectations ahead of close of the transaction, and a well-defined set of "vows" to operate from.

What can fantasy football teach us about succession planning?

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Even though I played college football and for years have had numerous invitations to join various leagues, up until this year I had never played fantasy football.

This year, however, my second-grade son’s school had a “father-son league” fundraiser. So we signed up, and in the last few weeks I have learned a lot, to say the least – and there is surprisingly lots of crossover with succession planning. Here are a few similarities:

  1. Relevant experience matters. When we did our fantasy football draft at the church, I felt like I was walking into a room with NFL GMs. They knew obscure player names and how fantasy scoring worked. My son and I were total rookies in fantasy football even though I had played football in college. I had lots of “football experience” – but not relevant fantasy football experience.

        Similarly, it is likely you will only execute a succession plan once in your life (rookie), and if you sell your business, it will likely be to someone who has bought multiple businesses (relevant experience). As a result, you should surround yourself with advisers with relevant experience. This does not necessarily mean the         advisers with the most experience in general, or those you have worked with the longest, but rather those with M&A experience that as closely as possible matches the type of transaction you are endeavoring to do.

    2. Make a well-thought-out plan before you need it. In the draft room, everyone seemed to have laptops, fantasy football magazines, printouts, etc. As I sat there, I Googled “fantasy football mock draft” and used that, plus my son’s favorite players, as the basis for our picks.

        Readers of this column probably think I sound like a broken record, but one cannot emphasize the importance of having a succession plan for your business in place before you need it. The time, effort and money spent developing this plan will pay off when the big day comes -- expected or unexpected.

    3. Certain items are more valuable than others. I learned in fantasy football that wide receivers are the best way to score points. There are other important factors and positions, but if someone is able to draft a few good receivers, they will probably win more than they lose.

        When preparing a succession plan, the same is true. There are lots of factors to consider, but the most valuable is probably thinking through and answering the “W” questions. What do I want my company legacy to be? Why would I sell? Who do I want to run it? 

    4. Don’t make unforced errors. Even as a rookie, I am glad I have not made an unforced fantasy error yet. This would occur if I did not follow football news closely (likely) and ended up starting someone who is injured, has a bye week or is having a bad year.

       In a succession plan or business sale, there are controllable and uncontrollable factors. Do not make a careless omission or mistake on the controllable factors. Do you have clean financials? Do you have a good management team that can operate without you there? Is there proper buy/sell key man life insurance in place? Those are but a few examples. 

Due diligence: A seller’s perspective

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Congratulations!

Years ago you mapped out exactly what you want to happen with your succession plan.

You have worked with your family and a team of professional advisers to execute that succession plan and therefore have put your company in the best possible position for a sale – achieving both the financial and the nonfinancial objectives that are important to you.

You identified the exact right type of buyer for your business and within that group identified the exact right buyer for your business. (Note: All of these subjects above are explored in previous articles.)

A letter of intent (LOI) has been signed by you and your buyer outlining the major pieces of the agreement (sale price, type of transaction, transition period, etc.), and now you and your buyer have 60 days to get the transaction closed – a time period often called “due diligence.”

The hard part is over, right? For a seller who has not previously been through a sell-side sale process or is unprepared for it, oftentimes the answer to this question is NO.

Remember, the business owner has often spent their entire life building up this company, and thus has not sold a company before, so this process is totally new to them.

On the flip side, the buyer has to make an educated risk-reward decision, and so identifying as many potential company surprises before close is important to them before they commit significant capital to buy the business. Many times they cannot “see everything” in a business until they have executed an LOI with the seller.

During diligence, the buyer will often:

  1. Send in third-party accounting experts to conduct an analysis of the company financials and cash management practices. This is often called a “Quality of Earnings.”
  2. With the seller’s permission, reach out directly and/or hire a third party to reach out to key customers and vendors to understand how they feel about their relationship with the company.
  3. Conduct environmental and title review of any company-owned real estate.
  4. Have an attorney draft definitive deal documents (which seem more excessive than necessary and take the terms of the LOI into infinite detail).
  5. Iron out employment agreements with remaining employees.
  6. Hire a third party to conduct personality tests on remaining employees.
  7. Identify the bank they intend to use after the transaction, which will have its own set of questions and requirements (may include a “field exam”).
  8. Identify the property and casualty insurance carrier and employee benefits carrier they intend to use after the transaction, and they will have their own set of questions.
  9. Do an underwriting process for key man life insurance.
  10. Conduct background checks on key personnel.

... Just to name a few.

To the unprepared seller, this will feel like a lot and like they have to answer the same questions over and over again.

To the prepared and organized seller, all this can be done efficiently and with little heartache within the roughly 60-day time period for diligence. After which, thanks to the seller's well-executed succession planning plan, they will be able to move to the next phase of their life under their own terms.

Valuation lessons from Pokémon Go

John Mickelson, managing partner at Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. MGP intern Anthony Yang, a junior at the University of Iowa, also contributed to this article.

Like music written after the Napster era, Facebook, and skinny jeans, I am apparently being woefully left out of a new cultural phenomenon: Pokémon Go. As I have read in newspapers (yes, I still read the hard versions), this craze is infecting the nation and has whipsawed the valuations of its parent companies. 

But underneath the appalling stories of car accidents and trespassing lawsuits, there is actually a pertinent message about your business valuation as you consider succession planning strategies: ASSUMPTIONS MATTER!

Earlier we talked about key factors that impact valuation, but we did not discuss the intricacies of determining the valuation itself. Valuation is driven by a set of assumptions that business owners should realistically consider as they contemplate what their business is worth. One tiny change can make a big difference among the investor community.

So what does this have to do with our battling cartoon monsters? Well, let’s take a look at what happened to Nintendo, an owner of the Pokémon Go app. When the app was first released, 80 million people downloaded it within days of its launch and Nintendo’s market value shot up $7.5 billion. Mr. Market said: "80 million people! Think of the advertising! Imagine the data collected! A way to engage millennials!"  

But once Nintendo announced that they would not profit from the app as much as anticipated regardless of how many players they had, their value dropped by a hefty $6.7 billion. Ouch. A small change in investor assumptions had a huge valuation effect for Nintendo.

Of course, your business will not have nearly as dramatic of fluctuations, but the story serves as a good reminder about how finicky valuations can be. Simply assuming that your valuation will always stay constant, or steadily increase, rather than constantly validating the drivers of the underlying assumptions can get you into trouble when it is time to sell.

Is your biggest customer always going to stay with the company, or could they look for other alternatives?

Is your best salesperson planning to stay forever?

Is your technological advantage IP protectable and relevant for the foreseeable future?

So what can you do to ensure that you get the best valuation possible? Business growth and adherence to the factors mentioned previously will both yield a higher valuation, and you should also constantly challenge the underlying assumptions of your business -- because your buyer definitely will!

 

What factors are driving succession planning today?

- John Mickelson, managing partner at Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Demographic changes are driving succession planning. The Business Record recently hosted a breakfast titled “The Silver Tsunami.” Panelists discussed the large cohort of baby boomers who are currently in the workforce and seeking options for what to do after they leave the traditional workforce. Many of these baby boomers are business owners.

Why is a “Silver Tsunami” an important topic, and what does it have to do with succession planning? Let’s look at some facts:

  • 10,000 people each day turn 65, a figure that will continue for the next 19 years.
  • Estimates are that 65-75% of small businesses will be “for sale” in the next 10 years as owners look to retire, and the amount of value in the aggregate for these businesses is $1 trillion. And yet ...
  • Fewer than 30% of business owners have a succession plan.

Developing a succession plan can be an emotional experience. Business owners develop a connection with their business that is many times similar to that of a child. Like child-raising, there comes a point when you have to let go of total control.

Your job as a business owner is just like that of a parent – take steps to position your child/business to have the best chance to succeed once you are not involved on a day-to-day basis, which will eventually come.

There is no right answer for a succession plan, and it will be very individualized. Your succession plan should involve input from your family – whether they are in the business or not – and legal, accounting and estate planning advisers, just to name a few. There are also professionals who specialize in creating a plan.

The plan may change over time as circumstances change, which is fine, but the important thing is planning before you have to, when outside conditions may drastically limit your options. 

And finally for business owners contemplating their succession plan, it may be comforting to know that with such staggering demographic numbers, you are definitely not alone!

 

How the presidential election could impact your succession plans

John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. Article also contributed to by MGP intern, Nolan Hellickson, a SE Polk alumni who is currently a wrestler and economics student at Harvard University.

The 2016 presidential election has been one for the ages, from boisterous personalities to outlandish scandals. Overlooked amid the hysteria surrounding the candidates is some of their policy plans, which could significantly affect succession plans for business owners.

For the purposes of this article, we will examine proposals from the two presumptive nominees, Secretary Hillary Clinton and Donald Trump.

Clinton and Trump both propose changes to the capital gains tax rate. The capital gains tax applies to gains from the sale of capital assets, which include proceeds from selling a business.

To simplify the explanation below, we are making an assumption that the business owner is in the top income tax bracket, but this analysis can be scaled to other brackets as well.

The current policy in place is a two-tier system. Short-term capital gains (assets held for less than a year) are taxed at regular income rates, or 39.6 percent plus an additional 3.8 percent surtax from the Affordable Care Act, bringing the total to 43.4 percent. Long-term capital gains (assets held for over a year) are taxed at 23.8 percent, with the surtax included.

Clinton’s proposal lengthens the time period between the short and long-term rates, adds a 4 percent surtax for incomes over $5 million, and keeps the Affordable Care Act surtax of 3.8 percent. Her policy reclassifies short-term capital gains as gains on assets held for less than two years instead of one and taxes those at a total rate of 43.4 percent, with the surtax.

The tax decreases to 39.8 percent for assets held between two and three years, and follows with a decrease of 4 percent annually until after year six, when the rate matches today’s rates (23.8 percent) for incomes less than $5 million, or an additional 4 percent for incomes above.

Trump takes a different approach. His policy eliminates the Affordable Care Act surtax of 3.8 percent and reclassifies the highest income tax bracket to 25 percent. As a result, the short-term capital gains tax rate would be 25 percent and the long-term rate 20 percent. Trump keeps the existing one year designation to determine long-term vs. short-term.

Each candidate has social and economic rationale for why they believe their plan is best. The proposals are, of course, subject to Congressional approval.

Given the differing rates which could amount to significant differences in take-home cash from the sale of a business, it may make sense for business owners to work with their tax professional now and determine if the pending election should hasten their succession planning.

Candidate Capital Gains Tax Graph 

 

Soft side considerations for selling a business

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Last week we discussed non-obvious criteria that buyers use to value a business and that sellers should consider.

Beyond dollars and cents, there are also less-obvious issues sellers should consider before they make the decision to sell (hopefully voluntarily and not a forced sale).

Midwest Growth Partners recommends discussing these issues with a team of advisers which could include close family (both in and out of the business), attorneys, accountants, clergy, financial intermediaries, and financial advisers to name a few.

Here are a few of the important ones.

  1. What do you want the business legacy to be? Are you OK with the company asset being absorbed into another entity and the company as-is going away? Do you want the name and likeness to continue?
  2. How much operational involvement (if any) do you want in the future of the company? Are you wanting to move to your vacation home immediately after close or would you still enjoy working part-time or as a consultant?
  3. How much financial involvement (if any) do you want in the future of the company? Are you OK selling 100 percent of the company today and missing out on potential future gains? Are you comfortable not selling 100 percent or financing the purchase, but not being in control operationally?
  4. Do you have key employees (or all of them) that you want specific financial or contractual protections for?
  5. What will you have to replace personally if you are no longer involved with the business? Health insurance? Car? Assistant? Disability insurance? Memberships?
  6. Have you thought about what you will do with your time? Has your spouse thought about this?
  7. Have you thought about what you will do with your financial windfall? Have you done estate planning?

There are no right answers to any of these questions, but many times they can be as important if not more than the financial considerations in a transaction. 

What is my company worth?

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Business owners often consider their business to be an extension of themselves and many have a high opinion of what their business is worth. Telling the business owner the “wrong number” can be like calling their baby ugly. If they seek to sell their business though, they need to have a realistic idea of what it is worth. 

So how are businesses valued by buyers?

It is purely supply and demand and, at any given time, a business is worth exactly what someone is willing to pay for it. Period. Tire-kickers do not buy businesses, buyers do.

If you need help figuring this out, a reputable business broker or investment banker can provide you with a range of what is realistic.

The primary valuation techniques involve value of assets, including intangibles, and cash-flow. In addition to those, several factors can influence how buyers like Midwest Growth Partners will view the value of your business.

Here are a few of the less common:

  1. Would your business provide a competitor with an immediate way to enter a new sales or product market? If so, and if that company is interested in making acquisitions, that buyer should be willing to pay a premium for your business.
  2. Does your business have steady, consistent cash flow like an alarm company, which has a 95 percent annual renewal rate or is it lumpy cash flow that is more project-based like a general contractor? Buyers are willing to pay more for businesses with predictable cash flow.
  3. Are there leverageable assets in place? Commercial banks are increasingly picky on what assets they will lend money against. If your business does not have assets that a buyer can secure debt with, the buyer universe will shrink because it will require all-cash buyers and therefore the value will go down.
  4. Is there a competent management team in place that can run the business if you are gone? A buyer may have their own ideas for strategic or personnel improvements – but they will also be willing to pay more if there is a talented team already in place.
  5. Does the business require significant working capital during parts of the year to operate? A buyer will pay more for a business if cash is not tied up in inventory or accounts payable.
  6. Are capital expenditures and systems up to date? A buyer will be willing to pay more if they know they are not going to have to spend cash immediately to catch-up on deferred capital expenditures.

These are a few of many, but are a good way to start the process of determining a value. 

Should I use an investment banker or business broker to sell my business?

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

In previous articles, we have learned about potential buyers for your business, the golden egg syndrome, the importance of succession planning and delegation.  Today we will discuss whether or not to engage a professional to help sell your business once you have mentally decided to sell. So...should you?

It depends!

Hiring an intermediary – typically called a business broker or investment banker – to help sell your business is similar to the thought process of whether or not you should hire a Realtor to sell your house. There are pros and cons.

On the positive side, if you find a competent and ethical intermediary (not all of them are, so search around for references), they will do the “full-time job” of selling your business, leaving you the ability to do the full-time job of running your business. Owners who think they can do both are often sadly mistaken.

A good intermediary will also bring several interested qualified buyers into the process, thus creating a competitive environment, which theoretically will produce a higher purchase price or more competitive terms. The intermediary will serve as your trusted confidant to will represent your interests in the process.

The intermediary should also pre-qualify the buyers to ensure they have the requisite capital to facilitate the purchase (many buyers say they do, but do not).

On the negative side, the fees charged upfront (usually a one-time or monthly non-refundable “retainer”) and at transaction close (a “success fee”) are typically steep and can dramatically lower the seller’s take-home proceeds from the sale.

A success fee is especially painful if the business owner already has a handful of qualified buyers in mind who might have an interest in purchasing the business, have capital, and can close the transaction quickly.

An intermediary will also slow the process down as they gather information about the business, suggest a marketing plan, talk to potential buyers, etc. Depending on the situation, this may be OK, but if the seller is seeking speed and efficiency, a full-blown sell-side process like most intermediaries run will take too much time.

Finally, although intermediaries will require potential buyers to sign a confidentiality agreement, the fact is that reams of your private company data will go into the hands (and computers) of literally dozens – potentially hundreds – of strangers because the intermediary will reach out to that many buyers (and each buyer will likely have two to three people working on the transaction plus their bankers, accountants, attorneys, etc). Once that information is in other hands, it is very difficult to control access and dissemination. If the seller controls who gets the information from only working with a small group, this risk is mitigated.

Like many important decisions in life, it pays in this situation to gather all the facts, ask for many opinions, and then decisively make the decision that is best for you.

Who are the potential buyers for my business? Part 4

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Over the last few columns, we have learned about the pros and cons of family buyers, financial buyers, and strategic buyers.

The next type of buyer may be the closest to you day-to-day – your employees. Structurally this can be accomplished with or without an ESOP, which is a vehicle that is intricate enough to warrant an entire future post. So for today we will focus on a traditional employee purchase, sometimes known as a “management buyout” (MBO).

In an MBO, a group of employees that you get to select, pool their financial resources and purchase the business from you. Because you can select the buyers, you have more control on your business legacy post-close than with other buyers.

Oftentimes the employee-purchasers take partial or full operational control shortly after the transaction because they have already worked in the business, so a lengthy transition period is not needed as with other types of “outsider” buyers.

Because the typical employee does not have the financial wherewithal to purchase a business, an MBO purchase price is usually some combination of buyer cash, debt, and seller financing. Also because the transaction is taking place between two known and friendly parties, many times the purchase may happen over a period of time rather than immediately at once.

As a result, a negative for the seller in an MBO is that they may not truly “exit” at close – they still have significant financial risk in the business – one in which they are likely no longer operating full time.

A solution may be to access an additional source of funding for the transaction to fill the value gap. For instance, if there is a business worth $10 million, the employee-purchasers may be able to come up with $1 million between them, borrow another $3 million, and get the seller to agree to finance $2 million. This leaves $4 million unaccounted for.

The $4 million value gap is a perfect spot for a financial buyer (private equity firm). Financial buyers love backing a hungry management buyout team that is seeking to purchase and grow a business they know well.

This solves the problem for both sides – the seller immediately de-risks by getting most or all of their money out of the business at close, and the employee-purchasers have the capital necessary to effectuate the transaction.

Who are the potential buyers for my business? Part 3

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Last column we learned about one specific type of buyer for your business – a strategic buyer. As we discussed, these buyers may pay top dollar for your business, but the sale often comes at the expense of the culture you have worked hard to establish.

This week we learn about another possibility… a “financial buyer.”

A private equity fund or wealthy individual is a financial buyer who may seek to purchase your business with the goal of owning an asset that will provide them an attractive rate of return via cash distributions and an ultimate sale.

The financial buyer usually is involved at the board level and is unlikely to want to get involved in day-to-day management of the business. Therefore a financial buyer is likely to invest only if you (or your trusted designee) have indicated a desire to continue operating the business or they have industry contacts who can.

In addition to board-level oversight, a financial buyer will likely want to make financial investments in the business in order to grow it so it is more attractive when they sell it.

As an example, in one of our portfolio companies, we are currently renovating and expanding the office space to accommodate future growth and to attract and retain employees and customers. In another portfolio company, we are actively seeking complimentary acquisitions in order to expand the company’s geographic footprint. In both companies, we have a number of high-level employment positions to fill which will enable us to scale. While these investments will cost us money in the short run, we are confident that they will reap rewards many times over in the long run.

Financial buyers also will be more flexible in structuring a transaction to accommodate the goals of the seller than most other buyers. For instance, financial buyers may buy less than 100 percent or less than a controlling interest in a business (enabling a “second bite at the apple” discussed in this column a few weeks ago).

One of the drawbacks of a financial buyer, in addition to not paying as much as a strategic buyer, is that financial buyers are not likely to be “forever” owners. In order to achieve a return and liquidity, the financial buyer usually will look to sell the business in three to seven years, which may not always fit the time horizon of the seller.

Another down side is a small number of financial buyers have given the industry a bad rap (think Richard Gere in "Pretty Woman"). That is why it is important to confirm that the financial buyer you are talking to is (1) well capitalized so they can effectuate the transaction; and (2) trustworthy and a culture fit.

A financial buyer is not a fit in every situation but, if you are seeking to sell your business, is an alternative that is worth your time exploring. 

Who are potential buyers for my business? Part 2

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Last column we learned about one specific type of buyer for your business – family. As we discussed, mixing business with family can make holidays awkward if something does not go smoothly.

This week we will learn about another possibility…a “strategic buyer.”

A strategic buyer is someone who is already operating in your industry. Many times they are a competitor. A strategic buyer will have a “strategic” reason for buying your business (often called “synergies”).

The strategic buyer is often the buyer willing to pay the most money for your business, but is also the buyer that is least likely to care about your legacy or your employees because they already have their own culture (which they want to keep) and their own employees (which they want to keep). Eliminating duplicative costs as well as broadening their products/services into your sales channel (or visa-versa) enables the strategic buyer to pay more than someone from outside the industry looking in.

As an example, a transaction I worked on several years ago was a successful family-owned company who had created a consumer product that had a cult-like customer following. The product was sold exclusively in independent retailers and not in national big box stores and that was part of the culture that the founders and the consumers embraced.

A large publicly traded consumer products company saw how loyal the customers of this product were and determined that since the large company already shipped product to thousands of big box stores, they could purchase the cult-like brand and have an immediate uptick in sales because of the larger distribution footprint (“if a truck is already going to Wal-Mart with our toothpaste on it, why not add this product too!?!”)

The public company (a “strategic”) paid an incredible amount of money for the company (all they wanted was the brand) and proceeded to lay off all of the company’s employees. (They already had their own sales people, accounting staff, HR, etc.)

The public company then started to sell the product into its existing sales channels (big box national retailers) thinking that more consumers would mean more sales.

Unfortunately for them, this was the exact opposite of the culture the company was founded on and all the cult-like followers who had purchased product from independent retailers quit buying because they felt the company had “sold out” – which, in fact, they had!

Moral of the story: if you want to get top dollar when you sell your business, a strategic buyer is a good way to go, but you need to be careful about the intentions and strategy of the buyer if you have concerns about your legacy.

Who are the potential buyers for my business?

John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Selling your business can be a full-time job in addition to your full-time job of running your business. Before the sale process begins, it is helpful to understand what kinds of buyers there are and the pros and cons of each.

In all circumstances, you should pre-qualify buyers to ensure they have actual capital before spending any time with them. Many will say they do, but do not.

Based upon all of this, you may target or avoid certain buyers. Over the next few weeks we look in depth at different types of buyers. Today we have the most obvious – your family!

Family

A family member may be interested in continuing your legacy by buying and operating your company. When this works out, it is often the best solution as company heritage will remain and the transaction structure and timing can be extremely flexible.

For these reasons, a business owner may be willing to exchange getting a “top dollar” value for their business from someone outside the family.

However, when things do not work out…look out!

Thanksgiving dinner can get awkward when siblings feel treated unfairly because of a sale. A son or a daughter may also feel like they have to buy/run the business and not pursue their own interests, which can create resentment. In-laws happen and divorces of children can happen.

Perhaps worst of all, because structures can be so flexible to accommodate the sale, the business owner may not fully financially “de-risk” because of seller-notes used to finance the purchase. This puts them in the precarious position of exiting the operational side of the business, but having their nest egg still in the business. 

One possible solution for this problem is to have a private equity fund financially back your family member. This gets liquidity to the business owner and gets ownership and operational control to the family member.

Next blog we will learn about other types of buyers: “strategics” and “financials”.

 

Two bites at the apple: selling your business twice

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Business owners are approached by private equity firms who suggest that they get “two bites at the apple” in a proposed transaction. Since when did selling a business have anything to do with produce?!? Let’s unpack this jargon. 

The “first bite” is a partial ownership sale by the business owner to the private equity fund. The amount of ownership sold can vary widely and is deal specific. The first bite gives the business owner immediate liquidity which allows him or her to diversify their net worth away from the business.

With the new-found liquidity and a capital partner to take prudent risk with, business owners may also find themselves willing to expand their business in ways they would not have had they had to “go it alone.” 

While the business owner no longer owns 100 percent of his business, he likely will remain in operational control of the business, so he can continue doing what he loves. He will also benefit from working with a private equity firm, who should have experience in the relevant industry and be able to provide value-added support from a board level. 

The “second bite” occurs when the business owner and the private equity fund decide it is time for them to sell all of the business. This typically occurs 5-7 years after the first bite.

By this time, the prudent shared risks taken by the business under joint ownership and the value-added support from the private equity fund have ideally created an entity that is worth a tremendous amount more than it was at the first bite. Because the private equity fund specializes in M&A, they can help with the sale process to maximize value.

The net result for the business owner is a greater financial realization of his life’s work. Often the proceeds to the business owner from the second bite for his partial ownership sale will vastly outweigh the proceeds he would have received from selling 100 percent of the business earlier – and this, of course, does not take into consideration the amount he received from the first bite.

 Maybe produce is not so bad after all!  

Importance of succession planning for privately held businesses

- John Mickelson, managing partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Many business owners do not properly plan for their business in the event of their retirement, disability, or death. Reasons vary, but they are often as simple as “It won’t happen to me” or “I will get around it eventually.”

In fact, this is one reason why only a third of family businesses successfully make a transition to the second generation.

Key decisions must be made about the future direction of the business. Those decisions include how ownership will be transferred, if the business should remain in the family or be sold to a third party, and how estate taxes can be minimized. Not only will this have an impact on your heirs' financial future but, perhaps more importantly, having a plan in place gives your loyal employees peace of mind. 

Midwest Growth Partners has seen the importance of succession planning first-hand in central Iowa businesses. We purchased a company in Adel last year from the estate of the founder. 

His adult daughters – who lived outside Iowa – inherited the company upon the unfortunate death of their father. While it was a wonderful asset for the daughters, they had no intention of being involved in day-to-day operations and were faced with the burden of figuring out what to do with the business and the future of its employees. They also had to navigate the complicated and time-consuming process of selling a business.

Ultimately this story had a happy ending and Midwest Growth Partners was able to partner with the company president and purchase the business. Unfortunatel, many stories end with company assets being liquidated and employees losing their jobs.

The sooner you can put a plan in place, the better. It is important to include those closest to you in the planning process, which can give insight into which family members would be willing to be a successor to the business. This can help with identifying those who need to be trained to carry on your business the way you want.

Attorneys, accountants, and others can also help you through the process. The end result of having a succession plan can smooth the ownership transition and make it easier for everyone involved. This will help ensure that the business you have been working to grow will have a lasting legacy after you are gone (which hopefully will not be for a long time!).

Golden egg syndrome: why business owners take risk by not taking risks

- John Mickelson is managing partner at Midwest Growth Partners.

We often see business owners who already have a good business with the potential to have a great business. These owners have well thought out ideas to make their company even bigger and better.

When we ask why they haven’t done so yet, it becomes clear that in their mind the risk is not worth the reward. There is a fear of losing the steady level of success the business has been achieving, which we call the “golden egg syndrome.”

The golden egg syndrome is frequently found with more senior business owners who do not want to risk substantial capital at this stage in their career. It is also found in family owned businesses that do not want to fundamentally change the way their business has operated for many years.

Unfortunately, becoming stagnant over time is one way to quickly lose market share to your competitors and not leave as big of a legacy to your heirs.  It places the company and, by default, remaining employees, at a strategic disadvantage for the day when the owner is gone. 

Private equity can be a great solution for the golden egg syndrome. By selling a portion of a business, but continuing to own some and operate it day-to-day, business owners can achieve some personal liquidity and diversify their wealth.

The business owner then gets to share the capital risk of prudent investments for the company designed to grow their business with the private equity fund. Business owners also get experienced partners who can help guide them in making strategic decisions.

Finally, the private equity fund will be able to help facilitate succession planning – both with management and with remaining ownership – when that time is right. 

Why delegating authority increases your company’s value

- John Mickelson, Managing Partner Midwest Growth Partners, is IowaBiz's blogger on succession planning. Read more about him here. 

Many business owners have a difficult time delegating authority.  Fear of losing control, believing that they are best for the task, and a lack of time to adequately explain what needs to be done are all reasons not to delegate. In a perverse sense, many of these traits are what made them successful in the first place. 

However, all business owners will hit a point that in order to grow or transition ownership to the next generation, they need help. Finding and trusting employees who can carry out critical functions will allow for that growth. 

As a potential business buyer, Midwest Growth Partners likes to ask if business owners are able to leave their business for two weeks and not be needed. If the answer is yes, this shows the business is not built on one person. We find tremendous value in that and in turn businesses receive better valuations because less risk is associated with the business. 

We have seen several trends for business owners who delegate successfully including setting clear expectations for employees, letting employees know how they will be evaluated, that it is OK to make occasional mistakes, and then properly rewarding employees for outstanding performance.  

The most important thing though is giving your employees the authority required to do the job. Delegation is not really occurring if the employee has to check in with the business owner before they make a decision. 

Delegating authority can have a great impact on a business. It can also make the life of a business owner less stressful. Although it can be hard to give up some control of the business that you started, the potential rewards are worth it. 

What EXACTLY is private equity and how does it help with succession planning?

- John Mickelson, Managing Partner Midwest Growth Partners, is IowaBiz's new blogger on succession planning. Read more about him here. 

Outside of major financial centers, the image of private equity is usually associated with a pop culture reference and that connotation is typically negative. Think of Richard Gere in Pretty Woman breaking up a family business or political ads accusing Mitt Romney of cutting company health care. 

While the private equity industry has bad actors just like every industry, these perceptions are generally unfair and the private equity industry – especially the type of private equity funds in the Midwest – provide a critical function to orderly business succession planning. 

At its core, private equity is simply another asset class that investors can invest in to diversify their portfolio. Most private equity funds are a pool of capital made up of dollars from pensions, trade groups, foundations and, to a lesser extent, wealthy individuals. 

Through these vehicles, many people are invested in private equity and may not even know it. The pool of capital in a fund is managed by a fund manager who seeks out investment opportunities in private companies whereby the fund becomes the owner of part or all of that company. 

Private equity is different than venture capital and public equity. Unlike venture capital – which invests in start-up companies – private equity invests in established companies that are seeking capital for succession or growth.  As a result, private equity does not seek huge investment wins with the expectation of a majority of its investments failing.  Rather, private equity seeks stable, predictable cash flow. 

Likewise, unlike the publicly traded equity market (like buying a share of Principal), the market for private companies is illiquid and inefficient.  This creates challenges in finding good investment opportunities, but also a unique chance to own profitable private businesses that investors typically could not access with their own time or capital unless they invested via a fund.  

John.mickelson@mgpfund.com

515-421-4803

www.mgpfund.com

This site is intended for informational and conversational purposes, not to provide specific legal, investment, or tax advice.  Articles and opinions posted here are those of the author(s). Links to and from other sites are for informational purposes and are not an endorsement by this site’s sponsor.