Change favors the prepared mind

New decades mark new beginnings, and many middle-market companies are likely facing a major transition on the horizon, such as a CEO change, sale or other event that significantly affects the business’s leadership, financing and future. Seventy-seven percent of mid-sized companies have experienced a transition in the past five years, expect one in the next five years, or both.

The likelihood of a business transition has increased because of:

  • Baby boomer retirements. The youngest boomers turn 56 in 2020, the oldest 74. About 40 percent of middle-market companies are owned by boomers, and many others have boomer CEOs, according to U.S. Census data analyzed by SME Research. That’s a lot of transition waiting to happen from a family business handover or CEO retirement, to a business sale to another company or a financial buyer like a private equity fund. There may also be a hybrid transition, where an owner sells a large stake to an investor and begins to navigate toward retirement.
  • Dry powder. An astounding amount of private capital needs to be invested. Prequin, which specializes in collecting data for alternative-asset investors, says PE firms worldwide are sitting on more than $2.1 trillion.
  • Cheap debt. Interest rates remain low, and low capital cost makes buying more attractive.
  • Near record high valuations and prices. According to PitchBook, the median PE deal closed for a price 11.1 times EBITDA last year, the highest multiple in more than a decade. High prices tend to coax out reluctant sellers.

Leaders tell the National Center for the Middle Market that they’re getting, on average, four or five calls from wannabe buyers every quarter.

What are they doing about it?

Despite knowing a transition will happen, only one in five executives say it’s a top priority. They tell us preparation is crucial, but looking back, more than 40 percent began planning only in the year in which the transition occurred. The same number say they’ll wait to plan until change is in sight. Only about one-third have written succession plans.

That’s a mistake. Preparing takes time — and it makes a difference in the success of the transition, regardless of the type.
Virtually all the leaders whose companies were “totally” prepared for their last transition report a success. Indeed, almost four out of five say that it was more successful than they’d hoped. By contrast, in companies that were “somewhat,” “not very,” or “not at all” prepared, satisfaction plummeted to 33 percent. The costs? Lost sales, damaged culture, dissatisfied and defecting employees, and, in the case of mergers and acquisitions, lower selling prices.

No time to waste

Transitions can be unexpected — a leader becomes ill, an offer comes out of the blue — but that doesn’t mean companies should be surprised. Here are five things that will help you prepare.

  • Have the talk. Bring investors, family members and executives together to envision future options. How do key individuals see their future? Understand your stakeholders’ hopes and goals when there isn’t an immediate action to take.
  • Clarify decision rights. Many mid-sized companies are governed informally. Again, sort out who is responsible for what before a crisis occurs.
  • Clean up your books. Doing due diligence and knowing a company’s real value removes a major difficulty for middle-market dealmakers. Strong, clear accounting also helps improve management and performance.
  • Upgrade your stable of advisers. Do your lawyer, accountant and banker have — or have access to — the expertise you will need when a transition comes?
  • Deepen your ties to your best customers and employees. When change comes, and it will, you’ll want to know they’ll be with you on the other side.

 

Thomas A. Stewart is the executive director of the National Center for the Middle Market, which provides knowledge, leadership and innovative research on the U.S. middle market. The center is a collaboration between The Ohio State University Fisher College of Business and Chubb.