Stewardship: Management and Family Buyouts
By Tom Zucker,
An entrepreneur’s greatest feat is the successful transfer of control of the business. Many business founders believe sharing power with qualified managers is challenging, but the even greater challenge is often leading the process of decoupling the business from a driven entrepreneurial leader. The charisma and drive that created success must be focused on the crucial process of selecting the right option for ownership transition. The owner’s final journey can best be broken into three distinct phases: The Decision, The Transaction and The Release.
The first phase is where critical evaluation and decisions are made. Decisions are often masked by emotions and the desire not to offend family and/or leadership. One former owner described this phase as the most difficult because it required an honest assessment of talent and capabilities, as well as awareness of legal and financial structuring implications. The ability to honestly assess the capabilities of a family member or business manager to run the complex enterprise that the entrepreneur created is difficult. However, many businesses have ceased to exist shortly after an incapable successor took control. So what options exists when one’s heir or manager is not currently capable of running the enterprise?
- CEO Mentors: We have seen mentoring CEOs inserted to nurture less experienced business managers or family members who have the potential to one day run the family business, but may need more time and assistance to be ready for this important role.
- Redemptions (Earn-In): The ability to align one’s financial interests with those of the business is important to the success of the transition process. The use of redemptions or other staged transition strategies can enable an entrepreneur to remain in control, but slowly and tax-effectively transition the business.
- Private Equity Recaps: A very common tool for transitioning a business with a less experienced leadership group is via a private equity recap. Private equity and family office buyers can serve as a great resource for stewarding leadership talent. The experience, relationships and even CEO mentors that these buyers provide are excellent for talent development and can also provide immediate liquidity to the seller shareholders.
The decision to transition to a family member, key employees or an outside third party requires much thought. External resources exist to guide an owner through these decisions, including exit planning professionals, investment bankers, human resource consultants or peer affinity groups for closely held business owners. This is the most important phase and one that often requires the most time to evaluate and test an owner’s initial thoughts.
The second phase is the execution phase. After the decision and direction has been established, the next challenge is executing the plan. The majority of middle market business owners hire an investment banker to serve as a guide through this process. The key theme is keeping the momentum of the deal moving. If a manager group is one’s desired transition plan, then a defined timeline for confirming interest and securing the necessary capital is essential. Without an investment banker to advise the owner and move the transaction forward, many owners’ transition plans have been stalled or, even worse, held captive by the manager attempting to complete a deal. The most common delay for a manager is the inability to secure bank and equity financing. A capable banker can quickly assess and secure necessary funding.
A variety of structures are available to a manager or family member. These options include a redemption, employee stock ownership plan, staged management buyout and others. The legal, tax and business complexities are significant and require skilled transactional advisors in each discipline.
The ability to have a back-up plan for an owner’s transition is critical for ensuring success. We are engaged when a manager is attempting to buy out a business, or a pre-emptive offer has been made by a strategic competitor. Interest from the sole buyer and the evaluation of their conversation often prompts a larger discussion. An investment banker’s involvement provides deal guidance, but, more importantly, gives the early buyer the fear of a broader market offering which will often produce more competition and a higher purchase price.
After a letter of intent is executed, the deal will not materially improve. The ability to close quickly and without surprises is the sole goal at this point. The use of virtual data rooms, skilled advisors and a third party negotiating critical terms and conditions on the owner’s behalf if often essential to preserving the desired deal. The most common issue facing a management buyout or family transition is the negotiation of sensitive deal points with family or friends. The use of an outside advisor provides a welcome buffer and helps preserve future relations.
By this point, the deal has been completed and the stock has been transferred, but the owner has not mentally given up control of the business. The release of control can either be done quickly and fully, which provides a clear leadership control point, or it can be staged over time. The majority of transactions we are involved with require control and responsibilities to be transitioned over time. The slow transfer of power and responsibilities enables management or family to assume control on a more controlled basis. However, owners should beware of the domineering entrepreneur maintaining control too long because this may undermine the effectiveness of new leadership.
To ensure a successful release, the transitioning business owner needs a compelling future plan. Motivation and excitement may come from an owner leaving to spend time on an exciting civic project, donating time to a favorite organization, spending more time with family or even starting another enterprise. The compelling future is very important to both the selling owner and the success of the business. The ability for an owner to release control of the business is essential for new stewards of the business.
The ability to transition your business to family or management is appealing on many fronts. The freedom and financial rewards of business ownership are compelling. However, the preservation of one’s legacy as the business owner is often tied directly to the success of the transition plan. The three phases of the plan: The Decision, The Transaction, and The Release all require outside expertise to ensure good decisions and focused implementation throughout the process. An owner’s stewardship and transition of the business to family, management or an outside third party is often more difficult than the purchase or starting of the business.