Over the years we have worked on transition plans for numerous businesses and have seen them take many forms – from sales to children to gifts, deferred compensation arrangements, and ESOPs. In the early days of these engagements we would hone in on one transfer strategy, based on input from the owners. However, we learned that was a mistake and one that we have since corrected.
Rather than focusing on a single strategy, our process now drives owners toward being able to choose from any number of transfer strategies. We think that leaving all options open is wise. And in taking this approach, we focus on one very important thing – the health of the business.
“Business readiness” is a hallmark of a good transfer plan because by running the business to its maximum potential, the owners preserve all the options available to them. A business that is running optimally can garner a higher price if it is sold to a third party. Or, if it is being transferred to family members and/or employees, it will mean leaving them a healthier business.
In advising owners on this issue, we recommend taking a step back from the business and viewing it as an investment (the company’s equity), the same way they would had they given the money to their broker to invest in the stock market. This is a difficult separation to make because business owners are often also employees in the business, and that business is providing their livelihood as well as employing other family members.
However, if you can make this mental transition in how you view your business, it will yield numerous benefits because you will have a much more objective view of its performance. What return on invested capital should you receive, considering your level of risk in the business? When capital allocation decisions are made (such as new equipment purchases), are there clear expectations as to whether those investments will yield an acceptable return on investment?
This process is essentially what a third party goes through when they consider purchasing a business. Because they are not biased by emotional ties or long-standing beliefs, they can look at the business from an economic standpoint and evaluate it on its merits. Why not engage in the same rigorous analysis of your business to put it in the best possible condition for a transfer, rather than allowing someone else to do it? Why not capture the value for yourself, no matter your transfer strategy?
Perhaps the simplest way to look at it: why would you accept a lower return on invested capital from yourself than you would demand from another investment?
The companies that learn to look at their businesses in this way are the ones that create the most economic value for their owners and offer the most options in their transfer strategies.
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