Step-by-Step Guide to Business Transitions
In technical terms, a business transition is when the business is passed from one owner to another. This can be a family member, employee-share ownership program, or third-party sale at market value. Every plan will be unique because of the human factors involved, but all three types of business transitions have similar elements.
There are five phases to business transitions:
- Getting the Business Ready to Sell
- Actively looking for a Buyer or engaging the Family or Staff Member
- Due Diligence
The entire process can take anywhere from two to seven years depending on the needs of the sellers and buyers, market conditions, and the type of industry.
Phase One - Getting the Business Ready to Sell
Process: 12-24 months
- Get the company books in order
- Business valuation
- Identify internal issues
- Make a plan of action
- Take action
The first step in phase one is to ensure the books are in order. This allows you to understand what the transferable value of your business is and why it is that value. Not having the books in order can be the first delay in any succession plan.
Determining a value, and understanding the process, is critical because it will give you an opportunity to identify areas that you can improve to maximize your asking price. The business’s bookkeepers and accountants are beneficial at this point because of their background knowledge of the owner and business.
Certified Business Valuators (CBV) can also be engaged at this stage to identify the full transferable value of a business, beyond the tangible assets like equipment or real estate. By reviewing the valuation from a CBV, a company should be able to identify areas of improvement, build a go-forward plan, and take action to implement changes. By doing this exercise early in the process, the business owner will also better ensure the business isn’t dependent on one person, which will increase the value and likelihood of the sale.
Phase Two - Engaging the Family or Staff Member, or Actively looking for a Third-Party Buyer
Process: 6-12 months
- Communicate with staff and family or look for a third-party buyer.
There is a large emotional component to exiting a business, and the majority of owners feel it is important to their legacy to transfer their business to family members or employees. Unfortunately, almost none of the business owners we work with have had this conversation with the staff or family member they have in mind.
It may surprise some owners, but many employees do not want their boss’s job, or at least they do not want to run the operation themselves. Moreover, when the current business owner is also the founder of the company, the staff members not only see how many hours a business owner puts in a week, but also the financial risk they have taken on to be successful.
Therefore, the first step in phase two is communicating with a qualified employee, group of employees, or family member to see if they have any interest in taking over the business in the coming years.
If the employees or family members do not express interest, the business owner must then start looking for a third-party buyer.
Depending on the needs, timelines, and expectations of the business owner, there are multiple ways to list the business or look for a buyer. Services can be compared based on price, privacy, type of service provided, and geographic range to find a buyer.
A business owner can drastically increase their odds of finding a buyer if they engage one of the following services:
Commercial Real Estate Agents
- Commission based
- Privacy is low: all staff, competition, customers, and suppliers could know your business is for sale
- Strength in knowing the local market
- Personalized service
Online posting board
- Price varies
- Privacy varies
- Type of service provided varies greatly depending on the provider
- International geographic reach
Caution: Read the terms and conditions before signing up for any online classifieds board. Look for the percentage of commission on the sale price, whom they share your information with, other services you are obligated to sign up for, and length of contract with the provider.
- High commission on the sale of the business
- High privacy
- Personalized service
- The pool of buyers is dependent on the individual broker's network
- Low cost
- Potential for low privacy
- Limited service and geographic range
Compatibility with the buyer is important. The current business owner has successfully run the company for the past few decades; by finding an individual or group with the soft skills required to run the company, it will increase the level of trust in the due diligence process, allow a higher level of corporate knowledge transfer, and provide for the long-term sustainability of the company.
Phase Three - Due Diligence
Process: 1-12 months
During phase three, it is important to outline the expectations not only for the period the seller will stay on for, but also how it will internally affect operations.
Depending on the size of the company, timelines, and expectations of the seller and buyer, the due diligence period can vary greatly. To achieve efficacy, professionals such as accountants and lawyers, should be engaged early on.
Confidentiality agreements or down payments can be used to establish trust. Often both the seller and buyer are entertaining multiple parties at once and, in the interest of time and resources, both parties should individually establish BATNAs (Best Alternative to a Negotiated Agreement).
Throughout this phase, good paper makes good friends; all timelines and expectations should be well documented. By the end of the due diligence stage, both parties should have a crystallized sell price and understand timelines and expectations.
Phase Four - Financing
Process: 1-6 months
Financing the purchase can vary greatly, depending on the size of the company, tax implications, long-term agreements, and ability to finance the acquisition. Community Futures offers a wide range of financing options for business transitions including bridge loans and flexible payment terms. They also offer additional services such as assisting your buyer with writing their business plan. Business plans are requirements for financing from any lender. It is important to ensure your buyer understands this or it could hold up the transition by at least 3 months.
Due to the supply of businesses and the demand for buyers, business owners have an increasing need to become more flexible with the third party’s buyout or payment terms. Many businesses, especially in the trades, actively look for a third-party buyer and then implement their own employee share ownership program.
Another popular trend in financing a business buyout is the use of full or part vendor financing or Venture Capital (VC) funding if traditional financing will not cover the full amount. It is important for both sides to engage legal advice for any type of contract or agreement. Most VC funding likes to be engaged in the Due Diligence process, and that is why some companies that offer services to find a buyer also integrate introductions to VC funding into their systems.
Phase Five - Transition
Process: 0-60 months
An individual buying a business has a higher success rate than an individual starting a new business. This is primarily because of the competent mentorship that is often available to buyers. Many owners agree to stay on under a key employee contract for 6 to 12 months, giving the opportunity for a corporate knowledge transfer. As mentioned in phase two, compatibility of the seller and buyer is important to improve the working conditions during the transition phase.
The human resources of a company are often greatly affected by a transition; the new owner may want to make changes to the staff, policies, and procedures. Having agreements in place to outline who has the final say on any hiring changes or disciplinary processes can mitigate the escalation of any issues that arise.
Owners must also recognize that this is a major life event for them. Often a lot of their identity is connected to owning the business and it is the largest asset sale they will make in their lifetime. It is important to reflect internally about what they would like to do to find purpose in the next phase of their life.
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