Fobes Latvia, October 2021. Often when meeting a new client, we as investment bankers hear the same phrase: “I want to sell my company! Lowest price I’m willing to take is x million euro.” And a lot of the time, we have to break it to the business owner that at its current state their company cannot be sold at that price.
The pandemic has also been a catalyst for business owners around the world. Many have had to change their business model to adapt, some found that they now have to work more and for longer. During the pandemic people paid much more attention to their health and to the most important things in life and so we have seen an increasing interest in succession planning. According to the data from research done by the Swiss global bank UBS, within the next 5 years about 41% of business owners are planning on exiting their business. However, despite this increasing interest in succession planning, half of business owners still don’t have a succession planning strategy for their own company.
Often, especially in Latvia, the owners of the company also perform the operational leadership functions in their company, leading to all of the knowledge about the company’s development, all the most important business contacts, know how and intellectual property being aggregated in the hands of just one person. That is exactly what creates the biggest risk for the sale of these companies (key person risk), meaning that by way of unforeseen circumstances, the business that has been developed over years and years of work can quickly lose its value. All companies, regardless of their size or ownership structure should establish a succession plan, because it helps the business owner, their family, and employees to be ready for unexpected developments.
Succession planning doesn’t just mean a planned departure from an active position in one’s business for personal reasons. The owner must understand that the handing down of a leadership role to professional leadership roles, increases the chance of being able to sell their company at the right moment because the success of the company will no longer be tied to the efforts and presence of the company owner in the business. The right moment, of course, being not when the owner for whatever reason wants to sell the company, but rather when the development of the company has reached the peak of what it can accomplish on its own and when there is market interest in these types of businesses, meaning that there should be multiple potential buyers.
What should one start with? Questions you should ask yourself to create a succession plan can be difficult, but they will help in understanding how to proceed.
· What are your entrepreneurial goals?
· When do you want to stop active entrepreneurship?
· Do you see any business successors in your family?
· What are your key employees or potential successors?
· What is your business development plan and achievable goals?
· Who would be most interested in my business? Could there be multiple interested parties?
The next step is to be aware of what are your exit strategy options. Here I will mention the main ones.
Keeping the business in the family. For many family operated businesses, keeping the business under the leadership of family is the intended outcome, however, for most people this isn’t the best solution because succession within the family depends on the skills and interests of the next generation. The data compiled by the international auditing company PWC show a very grim statistic – only 12% of family businesses survive till the 3rd generation of successors. Moreover, by the 4th generation a whopping 97% of these companies have gone out of business. This calls back to the old Chinese proverb “rags to rags in three generations”.
Still, even handing the business down in the family counts as a part of a succession plan and it can’t be done chaotically and without forethought. At the same time, one should remember that nothing destroys a company’s value like conflict between the shareholders or wars among the company successors. If your successors don’t have any real interest in the company, don’t have the necessary skills or understanding of the business as well as can’t agree management and development of the company, the business you have spent years building will quickly lose its value. However, a well-made succession plan will allow your successors to enter new roles, continue to lead and develop the business or reap the benefits of this business while focusing on other things that interest them more.
Selling the company to a strategic buyer (competitor). In this case, one has to be well prepared, because usually competitors are well aware of one another and keep tabs on each other. However, this approach has many benefits – you know your potential buyers very well and can tell what might interest them the most in your company. In the case of market consolidation, buyers can use the synergy effect for both the income and costs of the company to increase the company’s profitability. At the same time, ambitious competitors who will see a synergistic potential in buying your company will also be ready to pay a higher price. Often even a non-profitable company with a significant market share can be sold to a strategic buyer for a high price. However, you do have to consider regulation regarding competition and related agreements for this scenario.
Selling the company to a financial investor. In contrast to the strategic investors, the financial investors will most likely be interested in keeping the current leadership team. Financial investors are usually interested in medium term ownership, looking to sell the company further in 3-7 years. There are many different funds including family-owned funds which manage the assets of a wealthy family (family office), private equity funds and funds that specialize in a certain industry. When talking to funds, timing is of utmost importance. If the fund has recently accumulated fresh cash, then it’s the right moment to approach them, but if all the fund’s money has already been invested somewhere, then approaching them is of little use.
Possibly the most important part in the created of a successful succession plan is finding an independent and experienced specialist, who can offer a valuation of your business, will help find solutions stemming from your own plans, can give a professional assessment of the market and will help you to create a structured succession plan according to your unique needs. You wouldn’t make decisions about your health without consulting a doctor who has knowledge and experience in the subject and succession planning should be no different.
How much is my company worth now and how much will it be worth in the future? A financial advisor can help you in finding the answers to these questions. Company owners are often too emotionally invested in their company and lack the objectivity to value it fairly. More often than not, business owners have disproportionally high expectations of what the value of their company might be, however, the opposite can also be true. A more accurate and precise valuation requires a structured approach, including knowledge on different types of valuation, methodology and detailed and relevant information on the current and future state of markets. Consider that a private equity fund and a strategic investor might value a company differently. Similarly, the company value can be affected by its current relationships. What is the majority control premium for selling a majority stake in the company compared to minority investments? What price can we see being paid for a similar company in the market? These are the questions that only a professional financial advisor can help you find the answers to.
The goal of a professional and structured succession plan is not only to maintain the value of your business but also add to it. For that to happen, the owner has to think through and create systems and processes so that the business can work autonomously. The most common mistake made by business owner is having a negative attitude towards handing the leadership role to a professional management team. If your business can operate without your input, it creates a bigger value.
Succession planning is not only relevant for more experienced business owners. Perhaps, when creating a new business, the exit strategy for it is one of the last things you consider. However, a smart business owner will admit that the decision made on the first day of making the company can have a decisive impact on the value of the company even 20 years down the road, because companies should be made with selling in mind. In the experience of Prudentia, this is the biggest strategic incompetency on the part of business owners. The true business is making a company to eventually sell it, that is the approach of a true businessperson. That is the main thing separating a businessperson from a regular entrepreneur. To be a true businessperson means to increase your capital, to look at it from an investors point of view. Because of this, the succession planning plays a very important role even in early business development stages so that when you do exit your business you can do so on the best terms.
Succession planning will give you a clear vision of the future of your business. It’s not a decision that only takes a day, but it’s never too early to start thinking about it.