As baby boomers retire, we’re witnessing the biggest transfer of wealth in American history. It’s a crossroads for family businesses: 43 percent do not have a succession plan, according to a 2016 National Bureau of Economic Research Family Business Alliance survey — and only 12 percent will pass on to a third generation. Many adult children are deciding they just don’t want to follow in the family footsteps.
The root word for succession is succeed. An objective team, including your attorney, CPA and banker, can help you successfully plan for the next chapter in your business’ life and avoid these common succession pitfalls.
Pitfall #1: Procrastination means stagnation.
Why do so many family business owners hesitate to prepare for that chapter?
Founders take pride in the enterprise they’ve created, as well as the quality of life they’ve provided for their employees and their families. They want to make sure any transition will continue to take care of the people who’ve helped make them successful.
In a family succession, they want to be confident that the new generation is ready to assume the reins. Sometimes, in the founders’ perfectionist eyes, they’re never fully ready. So they take a wait-and-see approach before settling on a course of action.
And family members may disagree on the business’ direction. One may want to run the company; another may want to sell out. To avoid emotional conflicts, owners sometimes kick the planning can down the road.
For a number of reasons, owners sometimes have to find an outside buyer. They want someone who will keep their business healthy for their loyal staff. A careful search takes time and that can delay crucial planning decisions.
It’s wise to start planning for transition three to five years before your target date, working with that trusted team of advisers. In family discussions, they can keep egos and conflicting agendas in perspective. They can also vet an outside buyer’s qualifications and sometimes even introduce the owners to solid prospects.
Pitfall #2: Valuation requires mediation.
The company’s value can be a stumbling block.
If family members want to sell, they may have unrealistic ideas about how much they can get for their shares. They also may not want to disclose issues that might reduce the company’s value.
Sometimes owners start retiring mentally before they actually leave. They become less engaged and that can weaken the business’ future profitability — a hidden hurdle to a realistic valuation.
Outside buyers want to be confident that the business’ cash flow can support the debt they’ll take on with the purchase.
To keep a valuation fair, a bank will do its own independent appraisal when asked to finance the purchase of the business. A buyer or seller may want to engage their own valuation to help guide the advisory team as the parties negotiate a sale. Buyers can also dig deeper to understand underlying concerns: talking to customers, checking online reviews, researching competition and making sure a buyer has the right experience. (The last thing you want is someone who loves the idea of owning a restaurant or a day care center, but has no idea what it actually takes. That can threaten the security of everyone working in the business.)
Pitfall #3: Succession means change, and change means risk.
No matter who takes over, they will have their own ideas. They may want to discontinue unprofitable lines, acquire new sources of revenue, modernize, add staff or buy property instead of renting. Those decisions can be rewarding, but also risky and costly.
Any transition can put a crimp in available cash. Taxes and buyouts take their toll —and business cash flow is the No. 1 reason why businesses fail.
Change often requires working capital and lines of credit. And that may lead to borrowing.
How the SBA helps ease the cash crunch
First, the U.S. Small Business Administration (SBA) puts a federal guarantee behind 75 percent of the loan. That makes it much easier for a bank to approve the loan.
Second, unlike most conventional bank loans, collateral does not always drive the approval in an SBA loan scenario]. The underlying cash flow of the business and the experience of the potential new owners is where the value of the SBA guarantee can alleviate much of the collateral risk, making it easier to approve.
Third, SBA 7A Term Loans for acquisition lending offer a 10-year repayment period they can be longer based on the historical cash flow, and longer than conventional bank loans of three to five years. That reduces your monthly payments, easing cash flow.
Fourth, new owners can limit their down payments to as little as 10 percent of the purchase price and in some scenarios have no down payment. There are no pre-payment penalties in loans with less than 15-year repayment periods.
Not all SBA bankers are alike. An experienced Preferred SBA Lender can move the process along faster, having expert knowledge of how the SBA works and provide a higher level of support to businesses in transition.
Planning ahead with trusted advisers is the best way to ensure the results you want.
Opinions expressed are that of the author and not Webster Bank N.A. Not intended as financial or any other professional advice. Consult a professional adviser with regard to your individual situation.
Robert F. Polito Jr. is senior vice president of government lending at Webster Bank, one of New England’s most active SBA lenders. He can be reached at firstname.lastname@example.org.