Dr. John H. Binkley Jr.

Why Now is the Time to Focus on Your Succession Plan

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If 2020 has demonstrated one thing above all else, it is that we can never take things for granted.

Life can be unpredictable, and this means circumstances beyond our control – be it a personal matter like a death or divorce, or a worldwide incident like the COVID-19 outbreak – can dictate the future for individuals, families and businesses.

While it is impossible to predict the future, it is possible to prepare for it, which is where effective succession planning can reap rewards for business owners. In turbulent times such as this, the value of having a structured plan for life can help cut away the chaos and offer an advantageous layer of security.

Yet, research conducted by Wilmington Trust in 2017 revealed that 58% of business owners did not have a specified succession plan for their organization.

I hope that recent events have resulted in this percentage declining, but it demonstrates that many are risking the continued legacy of their business and the value of their exit by not preparing for the inevitability that they won’t be in charge forever.

With this in mind, I’d like to use this article to discuss the importance of succession planning, outline the unhelpful assumptions that some make regarding the future of their company, and what a well-thought-out plan should incorporate.

What is succession planning?

At its most fundamental level, succession planning outlines the necessary actions to ensure a business will continue when the owner is no longer involved in the day-to-day operations. But, in addition, it also can play a key role in protecting the equity owners have built into their business, and consequently maximize the return they receive for their years of hard work and investment in the organization.

It is a roadmap for your business beyond your guidance. As the team and I at Generational Equity have noted time and again, owner dependence can be a major red flag for prospective buyers or investors – the closer you are tied to the success of your business, the more concerned buyers will be about its prospects without you at the helm:

  • Are you primarily responsible for your relationships with clients or suppliers?
  • Have you dedicated time to building and training your management team?
  • Do you delegate key decisions?
  • Are your business processes documented and shared, or locked in your mind?

Among the core components of any successful succession plan are factors such as:

  • Hiring and developing an effective middle management team
  • Building decision-making processes that extend beyond the owner
  • Creating a client relations team
  • Constructing a long-term strategic plan for the business

These are among the core steps that you can take while still at the reins of your company to best prepare it for when you let go. Not only will this support long-term business continuity, but it will also indicate to potential buyers that your company is sustainable and can still thrive in your absence.

Where do people often go wrong with succession planning?

When I consider the issues that many business owners have surrounding succession planning, one word always comes to mind: assumptions. More precisely, it is owners assuming that one of these two scenarios will take place:

  1. The business will be taken over by their son, their daughter or another family member
  2. The business will be acquired by one of their employees

While I am not suggesting that in certain circumstances these aren’t appropriate or workable, making the assumption without some serious conversations or considerations can have disastrous consequences.

First, let’s consider passing on the business to your offspring. Rather than making the bold assumption that they would like to run the business when you’re ready to depart, have a conversation with them about this idea.

They may have aspirations in another business or industry altogether, and if they don’t have the desire to run your company, or only do so out of obligation rather than choice, this can put the future prospects of the business you’ve spent years developing in jeopardy.

Furthermore, you have to consider objectively if any of your family members have the necessary attributes to run a company. It’s one thing to take on a middle management position in the business to gain experience – actually managing an organization is an entirely different animal.

Not to mention the insult that key employees could feel if you hand the company over to your child, particularly if they had no connection to the business beforehand.

And what about financing the transaction? Most likely you will be required to provide a long term note on the business, requiring your offspring to reach key financial metrics, post-acquisition in order to buy you out over 3-5 years (or more). Do your kids have the ability to meet these financial requirements and do you have the faith that they can?

So, what about the prospect of selling to your employees? On the surface, this appears preferable – if you have trained a strong middle management team that understands your company inside-and-out, assigning one of them as your successor can support a seamless transition within the company.

However, this benefit can be outweighed by the financial burden this imposes on the departing owner. Most key employees won’t have the same buying power as a professional buyer or a private equity firm has available.

This means that you will either be selling your company for less than what it’s worth, which shouldn’t be considered based on the blood, sweat and tears you’ve poured into the company, or you will have to carry paper financing the deal over a 3-5-year period (or longer). This is risky because, if the business falters outside of your management, does this affect the value of your buyout?

Of course this is the same issue you face if you sell the business to family members: Is the capital available to cash you out or will you be on the hook for a long term loan where you have no control over the success of the business?

What should a well-executed succession plan include?

So, what steps should you take to develop a successful succession plan?

Most importantly, determine your personal financial needs going forward. You need to meet with your wealth management team and determine how much you need for the next phase of your life. If you are financially able to provide financing to your family members/key employees for a 3-5 year time frame, then great, closely examine those two options.

However, if you are not, then the best plan is to look for buyers outside of your family and internal team. As tough as that may be to face, we have found that in most situations, a professional external buyer, with the resources to both cash you out AND provide for the ongoing growth of the company (and your legacy) is really a far better option for you and your company, family, and associates.

Start now to secure your financial legacy

Hopefully this has given you a launching pad to think about the importance of succession planning with your business. As 2020 has demonstrated all too clearly, your company is too meaningful and valuable to leave its future up to chance, or at the mercy of circumstances beyond your control.

The key now is to start planning if you haven’t already – the earlier you can begin cementing the facets of your eventual departure and what comes next, whether you plan to exit next year or in the next decade, the more you will benefit in the long-run.

This is why I recommend that business owners who have no exit plans in place, attend a Generational growth and exit planning conference. We have designed these to provide valuable information to business owners about the key components of a successful exit and how to do so in a way that maximizes the return to you.

Until next time, I wish you nothing but the best for the months ahead as we continue to contend with these challenging times.

A New Dawn for Deal Making?

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Back in April, I was delighted to learn that our team at Generational Group had closed our 900th transaction in company history. At any time this would be considered a fantastic milestone to pass, and I am of course incredibly grateful to the continued hard work of our associates and the wonderful support of our clients.

For us, every one of these 900 (and counting) transactions represents a business owner that we have helped secure their financial legacy, so that they can reap the rewards of their investment into their company and enjoy life beyond business.

Yet, considering the life-altering circumstances of the last few months, this achievement has a whole different meaning to me. It demonstrated that, even in these times of hardship, where families, communities and businesses have been changed forever, the resilience and commitment of entrepreneurs continues to hold firm.

Of course, the COVID-19 pandemic has changed deal making at least temporarily, which I will explore in this article. But, it is the perseverance of the entrepreneurial spirit, particularly within the middle market, that gives me a great deal of confidence for life beyond this crisis.

Optimism for the Future of Middle Market M&A

In my previous article, I highlighted several reasons why I remain confident in the foundations of our economy and the bullishness of buyers in the face of this unprecedented challenge. And I’m happy to report that a couple of months later, nothing has dampened this feeling. If anything, it’s grown even stronger!

The robustness of our banking system continues to be a source of comfort in these hard times for individuals, families and businesses, with central banks offering reassurance that they will be introducing measures to stimulate economic growth and protect incomes.

But beyond that, I’m encouraged by the attitudes of middle market entrepreneurs and their prospects for M&A activity after this pandemic. A survey of SME owners conducted by Permanent Equity recently revealed some reassuring statistics, including:

  • 32% of owners surveyed said their companies’ revenue had remained stable or even expanded during the pandemic
  • 40% expect their revenue will be back to 2019 levels within 6 months of life returning to some form of normality
  • 76% believe their business will emerge from the COVID-19 crisis stronger than before

These are great signs for the resilience of the middle market, and indicates that these companies are not statically waiting for this all to blow over – they’re adapting to the “new normal” with changes like remote working and investments in technology, which will then benefit them once we have overcome this challenge.

That’s an attitude we’ve also taken at Generational, changing our practices to protect the health and wellbeing of our associates across the country while continuing to meet the needs of our clients in these unique circumstances. 

Because, particularly in the lower middle market, transactions are still moving forward. While the press will often focus on the decline in billion-dollar deals due to the uncertainty COVID-19 has caused, the timeline to deliver ROI for smaller deals is significantly longer, meaning there’s less risk associated. 

But how has deal making changed in the face of this new landscape? How could this affect a business owner’s approach to planning their exit?

Exit Planning in the COVID-19 Era

When discussing how COVID-19 has adjusted the deal making process, I think it’s vital to start with how we should determine a company’s value.

Regular readers of Generational Equity’s insights will likely be familiar with recasting. That is when a professional M&A firm will examine your financials to account for any one-time expenses that would not impact on its new owners. These can include:

  • Losses due to fire
  • Losses due to employee embezzlement
  • Other business disruptions beyond your control (floods, earthquakes, tsunamis)
  • Any of your compensation that was above fair market value
  • Travel and vacations for you and your family that the company expensed

This is a widely-accepted process and helps provide a more accurate picture of your company’s worth for a prospective owner. However, moving forward there will be another important element to include on this list: the loss of revenue or income as a result of COVID-19.

As Northern Trust reiterates in a recent article:

Moving forward, we expect the due diligence process to include questions that help buyers better understand the specific impact of COVID-19 on the business, and its general level of preparedness for a global pandemic.

By accounting for this unprecedented disruption when recasting your company, you can offset any concerns or doubts of buyers, and also increase the likelihood that you will maximize the value of your business sale. 

Furthermore, if you are able to adapt your financial forecasts to demonstrate why your business won’t be greatly impacted by COVID-19, this can give you a significant competitive edge among potential buyers. Remember, private equity firms are still sitting on upwards of $2 trillion in dry powder – this still needs to be invested, and means a well-prepared company can still secure a premium on their business.

This recognition of COVID-19’s impact on business operations has led to the expansion of EBITDA to EBITDAC:

  • Earnings
  • Before
  • Interest
  • Taxes
  • Depreciation
  • Amortization
  • Coronavirus

No, this isn’t a bad joke – it is a reflection of the sizable effect that COVID-19 has left on many businesses across numerous industries.

As well as the transformation COVID-19 has had on determining business valuations, it’s important to consider how deals will be structured. We’ve spoken at length in the past about earn-outs and their prevalence in deal making, but in this new environment, they are likely to become even more sought-after.

Again, Northern Trust emphasizes this point, saying:

We also expect to see buyers paying a greater portion of the purchase price in the form of an “earn-out.” We believe sellers who adjust their mindset, show a willingness to be more flexible on deal terms, and who recognize that the transaction process is going to take longer in this new environment are likely to be at a competitive advantage.

This reinforces the need to be supported during your exit planning by a professional M&A firm, because this will help prevent any earn-out from being too heavily weighted in favor of the buyer: the deal structure also needs to benefit you (the seller). 

The advice of an experienced M&A advisor will also give you a clearer picture of what deal structures are more beneficial than others. This could allow you to establish an earn-out structure that is actually more financially advantageous in the long-term than a more cut-and-dry transaction

Fundamentally, we are in challenging times when it comes to deal making and exit planning. Information seems to change every hour, and it is important that, as a seller, you are working with a true professional that has experience in closing deals no matter what the economic cycle and understands how to secure an optimal deal structure.

Maintaining Your Journey to Exit

I hope this has given you a greater understanding of how M&A activity is continuing to take place, and how deal making is evolving in order to meet the challenge. 

Even in these difficult circumstances, dealmakers across the U.S. are striving to help push deals over the line, including our diligent associates at Generational, and I believe this should reassure business owners about their prospects of exiting both now and when COVID-19 has passed us by.

Above all else, I hope you take away from this the value of being supported through your exit plans by an experienced firm that has managed clients through all kinds of economic cycles. In trying times such as these, it is that experience and expertise that will keep your exit plans on track and keep you on course to an effective, satisfying exit.

If you want to keep up with the latest trends and news related to the economy and its impact on your approach to exit planning, I’d recommend subscribing to Generational’s regularly updated insights.

Until next time, I’d like to wish you, your family and your business nothing but the best as we continue to manage and overcome this challenge.

COVID-19 & Focusing on the Future for Middle Market M&A

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COVID-19 Middle Market M&A

In a matter of weeks, COVID-19 has changed the world as we know it in unprecedented ways. From restrictions on travel and mobility, to employees globally working remotely to bypass the pandemic, life feels like it has been flipped upside-down.

The M&A industry has not been immune to this impact. COVID-19 has been at the heart of current economic uncertainty, and subsequently this has caused deal making activity to slow in the short-term. Fortunately, at Generational Group we have continued to safely press ahead with transactions even at this tumultuous time.

As a recent roundtable meeting hosted by Axial highlighted, many deals at the Letter of Intent (LOI) stage are either pushing forward with urgency, or left on ice for the time being. While right now it is impossible to predict how long these existing conditions will remain, I am optimistic that it is a challenge we as an industry will overcome, and return to a state of ‘business as usual’ in due course.

Here, I explore my reasons for staying positive in the face of this crisis, and why I expect the M&A landscape to return to its once-thriving state when we can put these circumstances behind us.

Our economic foundations remain strong

Firstly, while COVID-19 has unfortunately resulted in numerous businesses shuttering short-term and a steep rise in unemployment, the underlying fundamentals of our economy remain strong in the face of this extraordinary challenge.

This is different from the banking/financial crisis we endured in 2008. Corporate balance sheets remain strong, interest rates are staying low and there is capital available to support business growth and acquisitions. But perhaps most importantly of all, our banking system is stable and its reserves are well above Federal guidelines.

As a result, we can be confident that our economy will hold firm against this temporary pressure, and will over time return to a positive landscape for M&A acquisitions.

In addition, the launch of the $2 trillion CARES Act stimulus package has bolstered the prospects for businesses looking to retain and take care of their employees. By providing quick funds and relief for SMEs during this time of uncertainty, this will be critical in keeping companies operational and supporting their preparations for the recovery period.

Private equity is still sitting on a mountain of dry powder

As noted, there is undoubted turbulence in the M&A market right now, and this should be expected for a little while. However, we are still seeing substantial buyer interest in spite of these challenges, which is reinforced by the capital available to these groups.

Private equity firms are a prime example of a buyer group prepared for when the market stabilizes. As Bloomberg reports, they are sitting on a $2 trillion war-chest of dry powder, all of which can exclusively be devoted to M&A acquisitions and investments. This puts them in a strong position to actively pursue opportunities as we start to recover.

Furthermore, Bloomberg’s article also notes how companies in a variety of industries will likely prove extremely attractive prospects for business buyers on the other side of the COVID-19 crisis, due to these being largely unaffected from an economic growth standpoint.

Buyers are bullish about future acquisitions

Meanwhile, Pitchbook revealed that a recent survey conducted by Ernst & Young suggested that around 56% of executives actively plan to pursue acquisitions in the next 12 months, which, remarkably, is an increase from October’s figure of 52%.

This is excellent news for business owners considering their exit plans in this uncertain state of affairs, as this demonstrates that when the world starts returning to normal, we can expect a major uptick in deal activity. Companies who have managed these circumstances and dedicated time to planning their exit strategy stand to benefit the most from this.

Plus, this is especially true for lower middle market businesses, because as Pitchbook states:

“For now, many dealmakers are forgoing transformational mega-deals in favor of smaller, discounted acquisitions.”

While the short-term vision for M&A remains a difficult prospect as buyers and sellers seek out firmer footing, these findings fill me with confidence that there will be a flurry of activity and opportunities when there is greater clarity about this entire situation.

Use this time to perfect your exit strategy

Hopefully, this has helped you join me in believing that COVID-19 will present short-term challenges for M&A activity, but will not completely compromise the optimism both buyers and sellers entered 2020 with. 

While I recognize this can be difficult to visualize considering the present environment, there are reasons to be upbeat about the future of the industry – and with it, your prospects of achieving an optimal exit.

Right now, my advice to business owners is to dedicate time to exit planning, especially if this is something you’ve not commenced with already. This anticipated slowdown of deal activity in the short-term gives you the opportunity to consider your next steps and build a buyer-ready business to coincide with when the world starts its recovery.

Remember, it will take 90-120 days to complete the critical first step in your exit journey – an initial business evaluation. Starting early with your exit strategy puts you in a strong position to effectively market to buyers preparing for normalcy to resume, and will help you secure an offer that accurately reflects the value of your company.

Our team at Generational Group can support you throughout this journey, even during these challenging times. Our associates continue to operate at their typically high standards, working remotely to ensure their safety while we continue to communicate with clients digitally. These include virtual versions of our informative exit planning meetings, where our experienced advisors break down the steps to maximizing the sale of a company.

I’d urge anyone to get in touch with our team to get a head start on their exit plans while activity is on a temporary slowdown – I’ve never met someone who regretted beginning this process earlier than they needed to. 
Also, for more up-to-date information on how COVID-19 is affecting the M&A landscape – and what this means for prospective sellers – make sure you’re subscribed to Generational’s insights. With news fluctuating all the time on this topic, staying informed has never been more crucial.