Never Too Early to Begin Transition Planning--Part 1

Being proactive provides more options and helps align the long-term interests of the owner with the long-term direction of the company
By Tom Doyal, P&M Corporate Finance
May 1, 2007

Too often, business owners spend their time working in the business rather than on the business. When the time comes to transition—whether that means turn the company over to the next generation, seeking new investors or selling altogether—they’re shocked at the amount of work involved. Moreover, these business owners generally leave themselves too few options and don’t know where to begin.

Most business owners never consider the need for an exit plan and do not proactively assess the various alternatives that are available to them in the future. Many only react to a potential suitor or an approach by their management teams without considering the opportunities that could develop through a proactive sale process. 

A successful transition plan encompasses several different components, from financial and estate planning to ownership transition planning, communication with employees and family dynamics. It can takes years to do this correctly.

Simply put, there’s no such thing as “too early” to plan for transition and exit strategies. Today’s quick-changing markets demand that privately held businesses step back regularly and assess the future. It’s always the right time to ensure the survival—and prosperity—of a business you spent the better part of your life building.

Every privately held business will go through some form of transition. You know it, your employees know it and your customers know it. Over time, a business owner’s lifestyle, family obligations, and tolerance for risk and reward will change. Likewise, markets can and will change. All of this is unavoidable and to be expected.

Then there’s the unexpected. The loss of a key employee, or the sudden death, disability or health concern of an owner or key employee—these are unavoidable. Failure to plan effectively can cause undue uncertainty and stress for the organization and management team. It makes transition all the more tenuous and difficult.

Effective planning, on the other hand, prepares owners, heirs, employees and customers for future change. It sets the foundation for strategic and operational decision-making and aligns the owners’ long-term needs with the goals and objectives of the company and its management. It also increases the probability of an efficient wealth transfer through long-term tax planning. Finally, it allows owners to extract value from the business in lower-risk scenarios. In short, it reduces anxiety and eliminates confusion, allowing enough time to create multiple options so that the organization is poised to make the best decision when the time arises.

There are three key elements to developing a holistic business transition plan, assessing both risk and rewards through personal planning, business planning and exit planning. All are interrelated and affect the success of each other.

Personal planning includes financial planning, estate planning, assessing family dynamics, and personal growth and fulfillment planning.

Financial planning ensures your retirement dollars are “bullet proof” and will provide adequate resources for your retirement and estate goals. How much money will you need to retire? What are your investment options? Do you want to diversify your holdings?

Estate planning addresses the transfer of assets from one person to another, typically family members or to others through special gifts. The primary focus is on efficient tax planning. The benefit of this stage is positioning assets, thinking about who should receive the benefit of the wealth that’s been created and when and how they should receive it.

Are family members involved in the business? If so, this raises some often difficult issues. The owner must step back and assess the capabilities of younger family members to move the business forward. Can they eventually run the company? Do they possess the right skills? How will the ownership be structured? How will the successors be paid? How do you ensure fair treatment? These answers aren’t easy to get to; it may be beneficial to consult with a third party for increased objectivity.

Finally, the personal growth and fulfillment stage helps the owner determine what’s next. Who are you beyond your business? What passions or callings do you favor? Do you want to remain with the company in a new role, or explore new opportunities? If you don’t know what’s next, the tendency is to dig in your heels and resist the process, implicitly and explicitly sabotaging it along the way.

Business planning includes strategic planning, operational planning, financial planning, and management planning. The strategic plan is the roadmap for the long-term direction of the company; it includes a strategy for the ultimate ownership transition. It provides the organization with a view of the future and a foundation from which to make decisions; it also aligns the long-term interests of the owner with the direction of the company going forward.

Strategic planning becomes more powerful when linked to a specific, tactical operating plan that outlines responsibilities, deliverables, investment requirements and return objectives. The goal of operational planning is to set and measure future results, reducing the overall risk of the company in the eyes of the new owner. By reducing risk, an increasing value proposition is developed, as the new owner looks forward to new opportunities versus a focus on historical performance. This creates perceived value, as risks are discounted, making it easier to sell the future opportunities of the company—which will undoubtedly look better than the company’s past performance.

The financial plan measures the results of the strategic and operational plans. It’s different from an annual operating budget given its longer-term nature, and should look forward at least three years. Optimally, the financial plan reflects both actual and forecasted results. It should also reflect changes that may have occurred unexpectedly and the company’s reactions to those situations. Finally, it can reflect pro forma adjustments due to one-time or extraordinary events that are sometimes lost in traditional financial reports.

The financial plan can also become a tool to measure the long-term results that are expected from new initiatives. Is the return worth the risk? Does it secure long-term value creation? Modeling expected results in comparison to historical performance can help you assess new opportunities in comparison to plans already underway.

Exit planning requires acknowledgement of three major factors. What are the future liquidity needs of the owner? Will family or current management be part of the transition plan? How much is the owner concerned with the long-term continuity of the organization or relationships with current employees and customers?

That said, there are five internal transition strategies and three external processes to consider. Each has its own pros and cons and can generate very different financial results. Internal strategies include:

  • Gift to Family Member. Companies can be gifted to the next generation, usually providing a tax-efficient transfer of the value of the stock, but not generating liquidity. Proper tax planning is critical. The benefit here is the continuity and transfer of wealth within the family, perpetuating long-term financial support.
  • Sale to Family Member. Similar to gifting, the company can be sold entirely or in smaller segments to a family member. Determining the value of the business is crucial, and may be difficult. This particular strategy has a tendency to cause friction between family members; an intermediary may be helpful to help sort through these issues.
  • Sale to Employees. An Employee Stock Ownership Plan borrows money from the bank to buy the seller’s share at fair market value. The company makes annual retirement contributions to the ESOP to repay debt. As the ESOP repays debt, shares of the company are allocated to plan participants. This strategy can be a powerful tool to motivate staff members, but creates fiduciary responsibilities for management.
  • Sale to Management. In this strategy, the management team borrows against company assets and cash flow, or partners who have an equity sponsor to purchase the company from the owner. This can be attractive when the team has been instrumental to the growth and well-being of the company and is integral to future success of the company.
  • Leveraged Recapitalization. In this strategy, the company borrows sufficient funds to redeem a portion of the shareholder’s current ownership position. The company amortizes debt over a long-term period while the shareholder diversifies their personal financial position through an alternative investment strategy. This allows ultimate control of the company to remain with the owner and the family.

    External processes include:
  • Equity Recapitalization. Here a private equity fund acquires a majority interest in the company. Typically, the owner retains a minority interest (15 to 40 percent) and remains responsible for day-to-day operations. A new board of directors supervises long-term strategy.
  • Sale to Financial Buyer. In this instance, a financial owner/operator acquires a 100 percent interest in the company, and management transitions to the new owner.
  • Sale to Strategic Buyer. Here a strategic acquirer, typically in the same or similar industry, purchases a controlling interest in the company.

This may all seem a bit overwhelming, but the tough part is always getting started. It’s often helpful to approach each stage individually and allow the plan to build on itself.

First, set up a timeline to determine when key milestones should be accomplished. Next, determine who should be involved. Family members? Management and key employees? The company’s board? Finally, who else should be consulted? After all, you can’t do it all. At a minimum, you’ll need accounting and tax assistance, to address financial planning and retirement issues and prepare easy-to-understand financial statements; investment banking assistance, to determine your business’s fair value and potentially execute an exit strategy; legal assistance, to prepare the business for a smooth ownership transition, and uncover potential liabilities; and business consultants to assist with strategic and operational planning.

In conclusion, business transition planning is a lengthy process; it can’t be done overnight. By planning well and planning early, you will have as many options open as possible to make the best decision for your company, staff and customers.

G. Thomas Doyal is a managing director of P&M Corporate Finance, and has been with the firm since 2001. His responsibilities include managing the firm’s Chicago office, leading the group’s construction and building products industry team, as well as participating as a member of the firm’s board of directors. He is available to answer questions or comments at 312/602-3604 or

G. Thomas Doyal is a managing director of P&M Corporate Finance, and has been with the firm since 2001. His responsibilities include managing the firm’s Chicago office, leading the group’s construction and building products industry team, as well as participating as a member of the firm’s board of directors. He is available to answer questions or comments at 312/602-3604 or