Jack and Jill started their very profitable business more than 30 years ago and have built it to more than $4 million in annual revenue and 25 employees. Last month, Jill asked Jack to put an exit plan in place, one that would allow them to be out by age 70.
Although Jack is nearly 69, he has no succession plan other than a belief that their daughter, Jenni, may want to take over the company. While they really want to sell to her, Jack and Jill have serious concerns as to whether Jenni would be successful as a business owner.
Jenni has worked for the company for eight years and is currently doing very well as vice president of sales. She’s extroverted and likable, and she has a lot of the right education and work experience to succeed.
Still, Jack and Jill see a few signs that worry them. For starters, Jenni has not been groomed for business ownership. Also, she is about to be married, is in the process of buying a house and wants to start a family immediately after the wedding. Three major life milestones in a brief period—while simultaneously taking ownership of a business with 25 employees—sounds like a recipe for disaster.
Why a Generational Transition Is So Hard
I frequently meet business owners like Jack and Jill whose retirement plan is to sell their business to a younger family member or key employee. Frequently, I find these owners have not thought through some critical elements such as: “Is the identified successor savvy enough to sustain and grow the business?” and “Can the potential successor afford to buy the business?”
Most business owners want to maximize the selling price of their business. They also want cash at closing so they can move their dollars to a diversified investment. The business is their largest asset, and they need the proceeds from its sale to fund their retirement.
What business owners planning to sell to a younger generation don’t realize is that the financial logistics of starting a business are different from those for buying a business. A business can be started with very little cash, and growth can be funded organically. But the acquisition of a mature, ongoing concern will require access to capital and frequently more than the younger generation can manage.
What will Jenni need in order to acquire Jack and Jill’s business? Can she afford it? Back-of-the-napkin calculations yield a selling price of $1.5 million. Jenni doesn’t have that kind of money lying around, so she’ll need to find financing. If she goes to a bank for an SBA-guaranteed loan, she’ll need to put in 20 to 25 percent equity—$300,000 to $375,000.
Jack and Jill could gift the down payment to Jenni or sell the business to her at a substantial discount, but neither of these options would meet their financial needs for retirement.
4 Tips for a Successful Transition
While there are many aspects to selling a business and transitioning ownership to the next generation successfully, here are four
- Plan ahead. A successful transition plan takes at least three to five years, and it’s never too early to start. If Jack and Jill had planned, Jenni might be better prepared to buy their business.
- Confirm your successor. Have a conversation with your family member or key employee about acquiring your business. Do they really want the business? Or is it just a nice idea? Don’t assume you know their intentions.
- Groom your replacement. Prepare your next-generation successor with the training, education and hands-on experience they’ll need to operate the business successfully when you are no longer involved. This will take time, so see Step 1.
- Access to capital. Work with your intended successor to plan ownership transition in a manner that meets everyone’s financial goals. Again, refer to Step 1.
The story of Jack, Jill and Jenni is a relatively simple situation as it involves just one child. Imagine how complicated it can become if two or three adult children are involved. Is it realistic for you to sell your business internally to the next generation? Does your family member or key employee have the desire, business acumen and financial strength to make it happen? Don‘t just assume. Have the conversation. Today, not a year before retirement!