Why business transitions often fail
Read time: 3 minutes
An ownership change can be highly disruptive for a business. Only two in five companies met their financial expectations a year after a transition, according to a BDC study of 200 Canadian small and mid-sized businesses.
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 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, a Managing Director 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. Half of the businesses in BDC’s survey failed to meet financial expectations. Another 20% found themselves in severe financial difficulty.
“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
Transitions involving an insider (managers or family members) tend to do better than those with an external buyer. Just under half of insider transitions meet financial expectations, BDC’s survey found. Only about one third of external acquisitions do.
“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. 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.
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,” BDC’s study found.
To learn more, download our guide on selling your business.