Few challenges are thornier for family business owners than preparing for a transition of ownership. It’s a time for facing tough choices about the company’s future leaders and how the new owner will finance the transfer.
“About 70 percent of family-owned businesses will change hands over the next 10 years as the baby boomers retire,” says Krista Dobronos, senior vice president and Akron market leader for Westfield Bank. “Unfortunately, too many business owners have not planned sufficiently for this transition.”
At a minimum, this planning process should begin three years before the targeted ownership shift, Dobronos says, though five years in advance is ideal.
Smart Business spoke with Dobronos about transitioning family business ownership.
What elements should be included when planning an ownership transition?
About half of all family businesses don’t have any kind of succession plan on paper. The starting point should always be identifying who will take ownership of the business, whether it’s a key employee, a family member or an outsider.
A business owner should also consider to what degree they want to remain involved in the business. Do they want to remain an investor in the business or get out entirely? They also need to consider the best option for financing the ownership transition.
Exit planning isn’t only about the owner’s retirement. Ownership transitions can also be triggered by divorce, disability, an extended illness or unforeseen death.
What are some of the best financial options for family business ownership shifts?
It all depends on the company, its industry and those who will take over the company.
Some buyers may wish to pursue a traditional bank loan for the company, which is usually a seven-year term loan using a 10-year repayment schedule. The buyer of the business can also take out an individual loan that is guaranteed by the company.
When there is a gap between the purchase price of the company and the value of collateral to back a bank loan, the buyer may need to secure gap financing. Mezzanine financing, for example, is becoming increasingly popular, and usually takes the form of subordinated debt or an equity investment like preferred stock. The seller can also provide financing referred to as a ‘seller note’ for the buyer to cover that gap over a period of time.
What about transitioning ownership to a company’s employees?
An employee stock ownership plan (ESOP) can successfully finance an owner’s exit strategy, but it requires a longer planning process than other financing options.
An ESOP is a way that an owner can transition shares of the business to the company’s employees at a lower after-tax cost, providing employees an opportunity to build wealth.
How can business owners take emotion out of the equation when planning?
It’s important to make a decision that’s based not on emotions but on the sustainability of the business long term.
This is one of the reasons it’s so important to have trusted advisers you can turn to. Sit down with your attorney, banker, accountant, financial adviser and other professionals you trust to help you develop a sound perpetuation plan.
What do banks look for when they consider backing such an ownership transition?
With regard to the company, banks want to ensure there’s adequate cash flow to service debt related to the ownership change. Banks look at the industry the company operates in and how market forces might impact it in the future. In the new owner, banks want to see a track record of experience with that company or industry.
When considering supporting an ownership transition, banks spend time in the company’s facility or office to see them in action, observe the approach to staffing and understand their clients. This interview process is critically important for both sides. It’s like a courtship — the business owner should feel as comfortable with their banker as he or she is with them. ●
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