Business Owner Transition Planning

September 2, 2022

Small businesses are a major economic force in the United States, comprising about half of the country’s GDP and representing almost 27 million companies. The U.S. Census Bureau reports that family businesses, defined as those in which two or more family members exercise control, represent about 90% of American businesses. Another U.S. Census Bureau data set found that a little over half of U.S. business owners are age 55 or older.

Given these demographic trends and the vast scale of the segment, a significant number of businesses will undergo one type of transition or another in the coming years. For some owners, business is a family affair and intra-family transitions have been planned well in advance. For many others, a sale to a third party, to employees, or perhaps to a business partner may be the preferred option.

Regardless of the preferred path, a transition in business ownership represents a major milestone for the business and for the owner. Thoughtful planning, ideally initiated years before a transition, is key and greatly improves the probability of achieving desired outcomes.

The Transition Process

The transition process can be dynamic and complicated, and for most owners is a once-in-a-lifetime experience. Given the value at stake and the unfamiliarity of the process, obtaining the advice of an experienced professional team is critical to achieving optimal results. This professional team should include a CPA familiar with business and personal accounting, a mergers and acquisitions advisor experienced within the industry and value scale, legal counsel who can advise on transaction structures as well as family estate implications, along with a financial advisor who can help assess the impact of different transition options on the family financial plan and build a customized investment solution which reflects family priorities.

Part of the planning exercise is geared towards optimizing the value of the business and its financial impact for the family. The owner has often invested many decades in shepherding and growing the business, and great care should be taken to maximize the economics of the sale or transition. However, transition planning includes more than analyzing the financials. The non-financial aspects of transition planning are sometimes overlooked but are also important to consider. For example, it’s helpful to take stock of core values and principles that have been instrumental in achieving success for the business over the years. How will these values be impacted by different transition options? Thoughtful consideration of all factors can help an owner maximize the financial impact while also accounting for other aspects of the transition.

For the business owner, converting business value into liquidity means entering unfamiliar territory. While an owner may have built up liquidity outside the business over the years, they likely have not relied on financial assets to support their family. The business often remains the primary economic driver for the family, and it takes a shift in mindset to adjust to a new reality.

A number of questions relating to the owner and family should be considered. What does the next phase of life look like for the owner? Are there other family members who will be impacted by a sale or other transition? How do you incorporate family legacy during the planning process? While some of the answers to these questions may be imprecise and subject to change, this exercise helps to establish guideposts for decision making. The process of identifying what may come next for the owner also helps ease the transition from one phase of life to another that may look drastically different.

Scenario Planning

As owners transition out of a business, a common issue to address is the loss of control that many owners perceive after exiting the business. The owner has developed over many years an intimate understanding of the levers that they can pull within the business to adjust to the economic cycle, changing market dynamics and technology shifts, among other challenges. After converting business value into liquidity, owners can find themselves on unfamiliar footing.

This is where scenario planning can play a helpful role. For example, an owner may have some flexibility to consider an installment sale where at least part of the payment is received in subsequent years. Or an owner may stay on with the business and/or retain some level of company stock for a certain period of time. Earn-out provisions may be included in the agreement. In transitioning a significant portion of net worth from a business they know well to pool of liquidity, they may have concerns about how market volatility can impact the family finances. Scenario planning can model the impact of these variables, and as a result leave the owner with a clear understanding about which variables are most important and how they impact their plan. 

Post Transaction Investment Plan

Another way to mitigate the perceived loss of control is to ensure that the owner has a clear understanding of the investment philosophy for the transaction proceeds as well as a more granular understanding of portfolio construction. While the owner is not expected be an investment expert, having a good working knowledge of how the portfolio can be structured to serve their own specific needs provides valuable context to the post transition period.

In addition to developing an understanding for how and why the portfolio is constructed, reviewing cash flow projections can also be helpful. Although the owner conceptually understands that an income stream can be produced from a portfolio, it can be powerful to demonstrate specifically how various income streams can be coordinated to efficiently provide for the family going forward. Taking the owner from concept to a real-life application also helps to alleviate the sense of loss of control.

An important benefit of planning well ahead of the transition itself is that it provides a platform for the owner to give more thoughtful consideration to aspects of the transition that frequently get lost in the sometimes-frantic pace of activity that can lead up to a transaction. Plans can change and post-transition life may be different than what you expect. Giving yourself time to plan helps you articulate your most important guiding principles, which in turn helps you be more intentional and achieve better results, regardless of the transition path that you pursue.

At The Fiduciary Group, we invite business owners to speak with their investment advisor to explore all planning options. We realize that each entrepreneur’s situation is unique, and requires a customized, collaborative approach that takes personal goals and individual situations into account. As always, we are ready to guide you with data, market knowledge, and transparency to help you achieve your goals.