For business owners, although it may not be front of mind as you’re working through operational challenges, it’s a reality that one day, you will no longer be part of your business. The terms under which you retire, sell or transition ultimately depends on the succession plan you put in place.
A succession plan is a blueprint for your eventual exit from the business, but it also helps you realise the value you’ve created. An exit strategy can take many forms. It may be partial or full for the outgoing partner – you may choose to stay on in a different capacity or stage the transition, for example. It typically is part of your talent management strategy, giving high performers the opportunity to share in the business success and increase their sense of ownership in the firm’s future.
All of these strategies need to start with the end goal in mind, according to Danny Chung, Segment Head, the Built Environment, Macquarie Business Banking. In discussion with Craig West, CEO of Succession Plus, Craig quotes a survey published by the Exit Planning Institute, that 49% of business owners between 50 to 59 have no formal succession plan. When considering that almost half of the mature business population have no formal plans for their exit, it’s important that you’re part of the 51% who’ve considered their future formally.
“Think about your goals, and when you want to achieve them by,” advises Chung. These are often quite personal, but they also need to take taxation, legal and financial considerations into account.
Your successor may be an internal appointment, or they could be an external party. If looking at an external party, you need to make sure they are the right cultural fit for your business.
With internal appointments, being seen as a successor can be a powerful motivator for your most talented staff. Beyond their ability to generate income, you should look for leadership qualities such as their ability to motivate and coach others.
“Start grooming them to think like a business owner, and begin transitioning some client relationships across,” suggests Chung. It’s also important to educate them about the responsibilities and obligations that come with ownership – this is not a decision to take lightly.
“For professional service industries, the most common valuation methodology is a multiple of Future Maintainable Earnings (FME),” explains Chung. “By using this process we are working towards obtaining an estimation of what we reasonably expect revenues will be over the longer term”.
A multiple is then applied to determine the business valuation– this multiple will depend on a number of variable (qualitative) factors such as how the diversity and consistency of income, profit margins and client base, to name a few.
“If you’re the sole ‘rainmaker’ and you want to exit, the business will have limited value to an external buyer,” says Chung. “Most valuation models are based on multiples of future maintainable earnings so you need to get all staff billing, not just you.” There needs to be goodwill at a firm level, rather than a personal level.
While you’re still working in your business, concentrate on maximising its value. This may be done through focusing on efficiency measures, documenting processes and systems, and ensuring that financial reporting is current.
You can expect a lot of questions during the due diligence process, so be prepared to be completely transparent with financial reporting. At this stage, it’s also important to consult a legal adviser to get a new shareholders or partnership agreement, and advice on the most appropriate structures. “You need robust documentation to deal with different scenarios,” advises Chung.
Selling your business, or even selling down your shares, doesn’t always mean an immediate exit. You may want to transition out and still receive equity dividends or salary based on business performance, in exchange for consultancy services.
“You may still want to add value after you retire,” acknowledges Chung. “Be honest with staff about your plans – do you want to work part-time as a consultant or with a specific client?”
Macquarie provides innovative financial solutions to fund in new partners. For example, an engineering firm has four principals with equal shareholdings and they want to introduce two new shareholders with 10% equity each. Typically, the two younger staff members have limited personal assets outside their family home, or may be trying to save for a property, so the principals discuss alternative funding models with their Macquarie Business Banking Relationship Manager.
To purchase their 10% equity, Macquarie Bank could potentially leverage the cash flow of the business to fund in the new shareholders.
“The borrowers take on the debt in any entity advised by them or their accountant, and repay it at an agreed rate, but it’s secured by business and personal guarantees rather than their homes.”
Generally in these instances, agreed repayments may be structured to ensure that free cash flow is used to reduce the debt. This process can be structured so that free cash flow can be used to pay of any non-deductable debt in the first instance.
As can be seen, there are a number of factors to consider with succession planning. Starting and planning the process is paramount and the first step with regards to any sale of your business.
For more information, please contact Danny on 0438 223 765 or danny.chung@macquarie.com
