The Importance of Succession Planning
For business owners, thinking about the “next step” is not always easy, especially when getting caught up in the day-to-day of their operations. However, succession planning is imperative in securing both the owner and business’ futures. But what is the best option, and what are the different considerations in succession planning? Expert consultants share tips on how owners can navigate this course, and develop the right strategy for their respective situations.
Understanding Options and Timing
In “Creating an Effective Succession Plan for Your Printing Business,” Paul Reilly, partner, New Direction Partners — which provides investment banking and financial advisory services in the printing and packaging industries — says succession can be defined as, “a number of persons or things following one another in order,” or “the descent or transmission of a throne, dignity, estate, or the like.”
In other words, succession is an exit strategy, and as Reilly outlines, there are several options for how to ultimately transition one’s company:
- Selling it or merging with another company.
- Giving it away to charity.
- Gifting or selling it to family, or selling it to a key employee(s).
- Selling it to all employees, under an employee stock ownership plan (ESOP).
- Any combination of the above.
No matter the path an owner ultimately takes, the experts all agree that time is of the essence. According to Peter Schaefer, Reilly’s partner, between the business preparation phase, beginning the sales process, and the close and transition, the process can take up to six years.
“Even if a business owner is young, there needs to be a plan in place because what happens if that owner is hit by the proverbial bus?” he says. “I’ve seen many situations where owners waited too long to transition their business, either to sell it outside, to the inside, or bring in a professional management team, especially leading up to the Great Recession.”
Chris Falco, CPA, CBI, CM&AA, founding partner of Falco Sult — a CPA firm with services specifically tailored for the print and graphic design industries — has also noticed an uptick in owners rethinking their approaches and doing longer-range planning since the Great Recession. While sharing his general rule of thumb that clients should account for succession planning spanning five years, he emphasizes how a lack of preparation can create a significant gap in the seller’s expectation of what his or her business is worth and its real value.
“Where you are in the industry in terms of having cutting-edge, easier technology; needing to upgrade; and whether you have the management team in place — all of these things, if you haven’t looked at them ahead of time, will result in discounts, which can be dramatic,” he says. “Buyers know when to get a business cheap and zone in on the bottom feeders. I see it every single time we do a deal. Those that plan make more money.”
Determining the Right Path
When it comes to succession planning, there is no one-size-fits-all solution. Louis Caron, CPA, president/CEO of Printing Industries Association Inc. of Southern California, says it starts with owners asking themselves what might seem a simple question: what do they actually plan to do when they exit the business? “Most haven’t thought about exiting, and what you plan to do is tied into how much time you’re going to give to the person coming in,” he says. “Are you going to hand [over] the keys and go off into the sunset, or are you going to be part of the business, and how many days a week are you going to work? How is that transition going to happen?”
Another consideration is who’s behind them to take over the business. “Nine times out of 10, there’s nobody,” continues Caron, citing how many owners in the baby boomer generation are second-generation owners whose parents started the business and whose children are not necessarily following in their footsteps. With selling or gifting to family, he says, the best situations have been those in which the relative has had a “walk-the-shoes” experience working their way from the loading dock through the press room, all the way up. “They need to be conversant in the business and respected by the employees,” he adds.
“Owners need to go through all these scenarios to come up with a plan, and a very important step to that is establishing the value of the business. What does the business command if we sell to a third party, or what would it look like if I sold it to management?” says Schaefer. “With management, you’re most likely not going to get as much cash at closing, so you’ll need to provide seller financing and be paid out over time — that would be the downside. But, on the plus side, you know the management team and there won’t be the need for due diligence since they already know the ins and outs of the business.”
Selling to a third party, he says, often results in owners getting more of the proceeds at closing, as typically management or employees are not going to have that much capital or equity to put in to buy the company. But if selling to a larger third party, they’ll have cash in their bank account that can be paid at closing. “That’s the positive in selling, but the negative is that it’s an unknown,” he says. “What changes will the buyer make? You’re going to get them to know the business well during the process, but it’s always different when you bring in a completely new owner of the business.”
When selling to employees or the management team, Schaefer adds that typically in these transactions, the employees will put as much debt as possible on the company’s books simply because they don’t have much personal equity to pay at closing. “If they can go out and borrow 50% of the purchase price and pay that to the owner, then they’ll owe the remaining half,” he says. “The challenge is that all of a sudden you have a company with a lot of debt on its books, making it difficult to finance CapEx and make other investments you otherwise would have.”
The other option, he adds, is not selling. Owners can treat it as a lifestyle business, continuing to extract as much cash as possible, having hired a professional management team. However, Schaefer says this can be a dangerous proposition, due to a different leadership style and adding more expenses to the business. “We’ve seen many situations where owners have done this,” he says. “It makes earnings so negligible, when they get into a tough time, they’re not able to make it through.”
Similarly, in buyout situations, Caron says the challenge is hiring the right person. “You’ve established a culture, a customer base — they know you, and the salespeople are dependent on it. If the new person comes in and hasn’t been groomed, it doesn’t work out well. I’ve seen owners who have been through two to three people.”
According to Reilly, when measuring a business’ value, most buyers are going by multiples of earnings before interest, taxes, depreciation, and amortization (EBITDA). Generally in the printing industry, he says the range would be anywhere from a low of 3.5x, to a moderate high of 5.5x. Areas in which it could be higher is if the business specializes in growth areas such as packaging and web to print, if it controls customer data, or if it offers creative services. Reilly also adds the larger the company, the higher the multiple is likely to be, but its size and growth rate can increase the multiples it can achieve, as can the state of its capital investments.
Reilly also suggests the asset approach — looking at the net asset value of the company, estimating what fair market value is for the equipment, building, and any other assets, and adding these together. Then, owners take out their liabilities, including royalty payments. This provides two different ways to approach valuation that can be compared over time, he says.
Falco also advises owners to potentially rethink their approaches with taxes. “If you’ve been doing a lot of things for maximizing tax benefits over the past years, you want to think about not being quite as aggressive. Pay a little more tax right now — you’ll get that back tenfold based on the valuation when you sell,” he says. “A good two to three years out, make sure you’re not writing anything and everything out on the business. Be much more conscious about tax returns; buyers, especially on the private equity side, are much more sophisticated at looking at this. It reduces your credibility as a seller — don’t give them that ability to doubt your numbers.”
In addition to the numbers, management is a significant asset, regardless of the direction an owner takes their business. “Even if you’re selling to an outsider, you’re going to want to bring your top management into the mix because they are going to help you execute that plan,” says Schaefer. Falco agrees, saying in addition to the numbers and up-to-date technology, business owners need to think about having key staff around if they sell the business to an outside party. “Many owners and buyers out there are looking at the asset of the management team and placing a lot of value on that,” he says. “Buyers are looking for smoother transitions and having those teams in place is critical, as many are not experts in the industries they’re buying into. It can impact valuation for bank borrowing.”
Caron also suggests businesses think ahead to the up-and-coming generation as the eventual successors. “Find a younger person with a college degree, who’s going to start at the loading dock and work their way up. They have a lot going for them, and they’re worth a goldmine,” he says. “Our industry isn’t going to go away, and they’re the future of it, but they have to be indoctrinated into the process.”
Key Players in the Process
Along with securing the business’s management team, there are essential experts to consult throughout the succession process.
When beginning, Falco says owners should sit down with an attorney and CPA. “Those two individuals should be able to help owners step back and look at the business from the perspective of operations and really help them do a health checkup to see where the holes are as it relates to the key people and key resources needed,” he says. “CPAs can help evaluate if you have done enough investing in the business to allow the next generation to step in and be successful (i.e., have you been investing enough in infrastructure, or taping things together?).”
Depending on the business’ size and industry, he says owners should also engage someone in the M&A or business brokerage side of transactions. While there are many attorneys who can do this, he says they can’t necessarily market the business.
“Your attorney or CPA could have referrals, but look for a solid, reputable business broker or M&A advisor who can help you set yourself up for the sale, which can take six months to two years, depending on the industry,” he says. “They can help you valuate certain parts of the business, market yourself, research the market, and find the right people in your industry to target to help you maximize the value. There’s a little bit of redundancy with what the attorney or CPA might do, but they offer a different skill set in preparing you for the actual business transition.”
Looking Past the Current Crisis
For demonstrating their value amid COVID-19’s economic impact, Falco says businesses will need to look at their projections and strategies going forward, from how management will shift in ensuring workflow efficiency as employees work remotely, to how they’ll market their business compared to pre-COVID-19. “With higher unemployment, there might be potential employees out there who can work more strongly in this dynamic, and can adapt better than the employees you have now,” he says. “You have to think, ‘What do my projections look like in the next two to three years?’ That can impact value quite a bit.”
Schaefer says regardless of an owner’s segment, he or she needs to be completely proactive and take any cost-cutting measures possible to ensure profitability, including applying for government relief. “The faster you can demonstrate a recovery from the pandemic, the more valuable your company is going to be to the buyers,” he says. “Buyers have a perceived new risk that they didn’t see back in January or February. If you can demonstrate you were able to respond quickly and maintain profitability throughout, the more attractive you will be to buyers going forward.”