Why business transitions often fail
An ownership change can be highly disruptive for a business. Companies often have trouble meeting their financial goals, which can go as far as to endanger their survival.
It’s a worry even if you’re the seller. You want to make sure your business legacy lives on, that employees are okay and that any vendor financing gets paid back.
“People think everything will be beautiful after a transition, but they don’t do enough preparation to make that happen,” says Benoît Mignacco, Vice President, Portfolio Management with BDC’s Growth & Transition Capital team, which finances business transitions. “Forecasts are often too optimistic.”
Mignacco gives this advice on what you can do to keep a business transition on track.
1. Prepare for disruptions
Entrepreneurs underestimate the stress and turmoil of an ownership change.
“Profitability is affected by the costs of the transition, adjusting to the acquired company’s culture and unexpected expenses,” Mignacco says. “It’s important to do what-if scenarios to prepare for disruptions.”
2. Build in financing room
Transitions are often highly leveraged, leaving little room to raise more money if forecasts are missed. Making matters worse, businesses often use shorter-term loans to finance the transaction. Such loans come with lower interest rates but need to be paid back quickly. That squeezes cash flow in the critical 12- to 24-month period after a transaction closes.
It’s important to consider repayment terms—and not only the interest rate—when weighing financing options. Some lenders offer capital principal holidays, longer amortization periods and flexible repayment options.
“You often need more flexibility at the beginning,” Mignacco says. “If you absolutely have to hit your results to pay off your debt, what happens when you fall short?
If you’re the vendor and are providing financing for the deal, ask the buyer about their capital structure and make sure the business will be on sound financial footing after the transaction.
3. Consider an insider succession
In a management or employee buyout, company insiders pool resources to acquire all or part of the business. Funding typically comes from a mix of personal resources, vendor financing and external sources.
The owner and manager must first agree on a sale price, which is confirmed by a valuation. Managers then draft a shareholder agreement, approach financial institutions and develop a transition plan that incorporates tax issues.
The full transfer of decision-making and ownership powers to the successors can take place gradually, over a period of months or even years. The new owners then pay back the financial institution at a time and pace that will not unduly slow the growth of the business.
As in a family succession, insider buyers are already familiar with company culture and clients, and are more likely than outsiders to keep the owner’s legacy intact. An insider is also more likely to have a good handle on the company’s value.
“The culture of the business is often underestimated,” Mignacco says. “In an insider transaction, there’s less change in the culture of the business, and the employees feel more secure. The vendor also has a personal attachment to the successors and is usually willing to help if there’s a problem.”
4 tips for a successful insider buyout
1. Be transparent
Good communication between the owner and managers is important. For example, the owner should be sure to fully disclose information about the company that managers may not have known before.
2. Focus on the financials
Management buyouts usually require substantial financing, which in turn reduces cash flow. Cost cutting, improved productivity or increased revenues may be needed. Do a thorough financial analysis of cash flow, sales volume, debt capacity and growth potential. This will provide valuable information on the buyout’s prospects.
3. Choose skilled managers
The buyers will need to put in place managers with the right combination of skills to take the company through the transition period and run the business profitably.
4. Retain good relationships
Establish reasonable incentives for everyone involved. And remember that if the buyout bid fails, you will likely need to continue working with the potential buyers, so make sure discussions don’t get too heated.
4. Don’t count on synergies
Hoped-for synergies between the buyer’s business and the new one often don’t work out after the transaction. When they do, they often aren’t as significant as expected or take longer to materialize.
A formal post-merger integration (PMI) process is one way to increase your chances of obtaining the full benefits of an acquisition. It will allow you to establish the objectives for the acquisition and then put a project management structure in place to ensure the two businesses are properly integrated.
5. Foster solid management
The management team is key to a successful business transition. It helps when managers have a solid understanding of the business and a well-articulated growth strategy. “The strength, experience and pro-activeness of the management team highly dictate the future.”
To learn more, download our guide on selling your business.