Millions of U.S. baby boomer business owners are approaching retirement. And many of those people are preparing to pass the company reins to their family members and employees to create a legacy. In fact, an estimated $10 trillion in family-owned businesses is expected to change hands by 2025.
For the owners of privately held companies, it can be complicated to retire and cash out. That’s why they often turn to their banking partners for advice in navigating the financial elements of the transition.
Here are five steps we at Wells Fargo recommend that Miami area business owners take to prepare for and to make seamless ownership transitions from one generation to the next:
1. Start planning early
Begin transition planning at least five to 10 years in advance. It takes time to do it right. Planning provides time to develop a formal board of directors and assemble a team of advisors to guide business owners through the process.
In addition to securing a knowledgeable banking partner, owners should build relationships with trusted lawyers and accountants. They will prove invaluable. Effective advisors also advocate for transparent and accurate financial reporting. That helps valuate a business and, if needed, secure third-party financing for the sale. Having skilled accountants, lawyers, and bankers by the owner's side early is essential to a well-organized ownership transition.
2. Build a strong internal accounting system
A robust internal accounting system can make or break the sale's success, especially if it involves non-family members or third-party buyers such as private equity or strategic acquirers.
Most sales to non-family members require independently produced financial statements that give an accurate picture of the company's balance sheet (assets and liabilities) and income statement. Establishing a sound accounting system and having a financial officer beforehand removes the stress of producing three-to-five years' worth of financial statements from scratch when it comes time to sell. Skipping this step can be costly and can produce a low-ball offer.
3. Build a top-notch management team
Before initiating a sale, be sure to build a proficient management team. Having solid management and dedicated employees adds considerable value for buyers. Remember:
▪ Boost loyalty of essential employees through the transition by providing long-term incentives and deferred compensation.
▪ Rewarding the people who brought the business to the game can ensure a deep management bench when positioning the company for a successful ownership transition.
4. Get a third-party valuation
Pouring years of blood, sweat, and tears into a family business can create a skewed view of a company's true worth. Consider soliciting a third-party business valuation to ensure an accurate picture of its worth well in advance of a transition. A trusted, independent advisor is indispensable in determining the proper market value based on the company’s cash flow and income-producing capabilities. Consult with accountants, bankers, or lawyers for recommendations about getting a proper valuation.
5. Consider shouldering some financing
To help the next generation buy the business, founders can take on some of the financing themselves in the form of subordinated debt, preferred stock, employment contracts, or earn-out provisions. When feasible, buyers benefit from a combination of bank financing and seller financing. Seller financing increases flexibility. It also limits how much the new owners will have to depend on third parties for financing.
Today is certainly a favorable time to sell a business. Banks, strategic buyers, and private equity firms are flush with cash. Prepare now by investing in transparent accounting systems, assembling trusted advisors, and ensuring loyal employees and management teams for a smooth transition, when the time is right to create a legacy.
Robert Lozano is regional vice president for Wells Fargo Middle Market Banking in Miami. Email him at Robert.Lozano@wellsfargo.com.