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Why Do Business Owners Need a Transition Plan? Why Do Business Owners Need a Transition Plan?

Why Do Business Owners Need a Transition Plan?

Understanding key considerations for transitioning out of a business
 
Why do business owners need a transition plan?  Below are six core reasons:
 
  1. Transitioning out of a business likely is the most important financial transaction of an owner’s life;
  2. Transitioning out of a business is complex;
  3. The financial security of an owner and his or her family depends on the creation and implementation of an effective transition plan;
  4. Other parties may depend on the owner and the business, such as family, key management, employees, lenders, suppliers, customers and the community;
  5. Transitioning out of a business subjects the owner and the business to various types of risk; and
  6. With no transition plan, an owner will likely leave money on the table and fail to achieve his or her value-based goals (e.g., family harmony, owner legacy, maintaining culture, acknowledgement of employees, community impact, elevating the business to the next level, etc.).
 
Many businesses go to market each year and do not sell. One cause of this phenomenon is that countless business owners have not done any business transition planning. Many owners do not know all of their options for transitioning out of their businesses, and many may not even know what their businesses are actually worth. Given the lack of foundational planning around the transition, it makes sense of why and how many businesses do not sell when they go to market.
 
The transition planning process does not have to be overwhelming; however, the transition plan must be owner-centric. All business owners who desire to establish an effective transition plan must address the following three “universal” goals:
 
  1. Financial: How much after-tax money does an owner (and an owner’s family) need for future lifestyle and retirement expenses upon transitioning out of the business?
  2. Departure Date: When does an owner want to transition out of the business?
  3. Successor: To whom does an owner want to transition the business? 

After assessing and answering these questions pertaining to the “universal” goals, a few key next steps are set forth below to get started on the business transition plan.   
 
  1. The owner should obtain an independent appraisal of the business. One reason businesses do not sell is the owner tends to overestimate the market value of the business. It is crucial to obtain a professional opinion from a qualified appraiser to gain a realistic understanding of what someone else would actually pay to acquire the business given its current circumstances and characteristics. Obtaining and understanding the value of the business is the springboard to the transition plan.
  2. The owner should determine his or her financial goals and the goals of his or her family and work with a qualified financial planner to better understand what is needed from the business to achieve those goals. A number of tools are available to advisors to assist business owners in determining an appropriate amount of income and capital needed to achieve the owner’s financial goals and to obtain his or her desired financial security after the owner transitions out of the business.
  3. The owner should begin to develop a plan regarding his or her personal future following the transition, such as: how the owner will spend his or her time; how the owner will stay engaged mentally; how the owner will stay active; and how the owner will continue to be relevant in his or her community and otherwise. This step is about making sure an owner is personally ready to exit the business. Even if an owner intends to stay engaged with the business as a consultant or a member of the board of directors, business owners should not underestimate the importance of a personal post-transition plan.
  4. The owner should obtain professional advice on what transition options are available given his or her specific circumstances and goals. In general, there are four common transition options:
    1. Transition the business to younger generations of the owner’s family;
    2. Transition the business to co-owners or key employees;
    3. Sell to a third party; or
    4. Sell to an employee stock ownership plan (ESOP).

After transition options are identified that might work for the owner, the owner should commence a focused effort to improve the transferable value of the business. The transferable value of a business is what the business is worth without the owner’s involvement in the business. An owner must transition, so the business will no longer depend on him or her to the extent that it may today. A plan to accelerate the transferable value of a business likely would focus on increasing cash flow and decreasing risk, while being focused on reducing the company’s reliance on the owner’s individual efforts and time. Even if an owner does not intend to sell to a third party, an owner’s business still would benefit from a tailored value acceleration program. 
 
Value acceleration is invigorating, because it requires the owner to spend more time working on the business (on issues like strategy and manager development) and less time working in the business (on operation scheduling or routine administrative items). Value acceleration can be painful, because the idea is to identify and address potential issues with the business; however, each identified issue is an opportunity to increase the transferable value of the business. Some issues may be relatively routine and typical, while others may be more difficult to resolve. Whether consisting of a high concentration of revenue sourced from a single customer or dealing with a key manager who is not incentivized to remain with the business, an array of issues may be present in the business that require additional time and planning to maximize the transferable value. 
 
Finally, remember that transitioning out of a business is not an isolated event. It is a coordinated, comprehensive process. The business transition plan is not intended to be filed away and periodically reviewed. It is developed for the purpose of immediate implementation. A business owner should expect the plan to evolve throughout its creation and implementation. An effective transition plan may take several years to create and implement, so a business owner should commence a transition plan sooner rather than later.
 
This article is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
 
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