The tumult of the past 15 months is leading many business owners to think about retirement, but a local firm says only 1 in 4 have a formal succession plan in place.
Erik Schumacher, CPA and principal at the Grand Rapids office of Rehmann, recently spoke to the Business Journal about transition planning. He said numerous businesses stalled while others boomed during COVID-19, and a wave of business owners — inundated with new challenges — are deciding to sell their companies and retire.
“Similar to what we saw coming out of the Great Recession, there’s a generation of family-owned businesses or business owners who just survived COVID, where things are looking all right for them, but they’re not real interested in hanging out for another potential downturn or another COVID scare or something similar,” Schumacher said. “So, we do see a lot of clients, lots of businesses, starting to talk about transition planning, whether that be selling the business in the market to a buyer or looking at the next generation of family and preparing for that.”
If a potential sale is on the table, Schumacher said it’s wise to start the planning and due diligence process sooner rather than later for many reasons, including the likelihood of federal capital gains tax and estate tax increases under the new administration and the length of time it takes to close a sale.
Schumacher said Rehmann approaches transition planning from a few different angles. He helps clients with tax planning — understanding the tax ramifications of a potential transition — and the firm’s wealth management advisers helps business owners understand what their financial life will look like after any transaction — “whether that be helping the current owners plan for retirement, what their needs might be going forward, or in the case of some type of a divestiture or sale, what do they do with this new liquid wealth that they didn’t have previously, and how do they plan for the future in the next generations?”
Alongside the quick recovery the economy has undergone lately and the return to profitability and prosperity many businesses are seeing, Schumacher said there’s a lot of “dry powder” in the private equity space, i.e., PE firms have plenty of investment capital to spend, which makes it easier for business owners to sell to external investors rather than to an internal buyer.
“Private equity groups have a lot of capital to deploy, a lot of invested dollars that they need to put to work, and with that comes high multiples that they’re willing to pay for businesses, and businesses are doing well right now for the most part after the pandemic; we’re seeing a shot in the arm of the economy, and that’s helping things trend upward,” he said. “As a result, it makes it a little difficult for internal management or the next generation to meet some of the value that current owners could get in the private equity space or in the external market. That’s not to say that we’re not still seeing the internal transitions, but it’s becoming much (harder for internal buyers) … to compete with the external prices that (owners) could get otherwise.”
As prospective sellers are contemplating going to market, Schumacher said there are some ducks they should get in a row.
“A big trend in the industry over the last half decade or so is sell-side due diligence, so engaging your current advisers or others to take a hard look at the financial and operational aspects of the business to prepare for that, because any buyer in that external world is going to be doing the same thing as they’re looking to purchase a business,” he said. “It’s always best practice to understand what might be concerns during the transaction or items that need to be addressed that can help either create additional value before you go to market or at a minimum help you identify areas that you’re going to have to address with any potential buyer and be upfront with them about (so) it doesn’t negatively impact any purchase price in the future.”
Common pitfalls sellers should avoid include thinking of a transaction in simplistic terms and expecting it to go quickly — they almost never do — and expecting a higher level of after-tax cash than is realistic when the deal is done, Schumacher added.
Not all industries have fared alike following the pandemic, Schumacher said, so it behooves owners to go into transactions with an open mind about whether this is the best time to sell given the likely market value of their business.
As business owners are considering a sale, they should start thinking about how to protect their talent — especially their longtime employees — Schumacher said.
One strategy is to convert the company to an employee stock ownership plan (ESOP) company instead of or in addition to seeking an external buyer, he said. Another is to negotiate generous exit compensation packages with the buyer, and a third is to communicate with the buyer the value those longtime employees bring to the table and the talents they have that aren’t readily available elsewhere in the market, so that retaining the employees post-sale is an attractive plan.
The Business Journal has already reported on a large number of M&A deals that closed in 2021, and various trend reports early in the year indicated this will be a banner year for M&A. Schumacher agreed, noting in one recent week, he had at least five separate advising conversations, from early stage to signing letters of intent.
“It’s going to be a very busy 2021, for multiple reasons,” he said. “Again, there are a lot of companies that are coming out of the pandemic very strong, some stronger than they were when they went into it, which is positioning them well for a transaction. But you also have the tax rate discussion going on, which has got another group of individuals thinking that this might be the right time to take advantage of the current tax structure, assuming it doesn’t change before the end of the year. So there is a lot of activity going on in the marketplace, a lot of chatter, and I would say in 2021, particularly if somebody has an inclination that they are thinking about exploring the space, they will want to do it sooner than later, because as we get closer to the end of the year, there’s going to be a backlog of work for all the advisers and all of the private equity (firms) or buyers in this marketplace.”