CHAPTER 10

Transitions

Harry Taub had been a dentist for more than four decades when he decided he was ready for a change.

He didn’t feel like he could just close the doors of his practice and walk away. He had valuable equipment for his practice and patients he cared about too much to leave behind. He also had no one in his life ready to take over. His team was too junior and his kids had no professional experience with—or interest in—teeth.

Thankfully, Harry had another option. A private equity firm, which already owned 250 dental practices, offered the highest price for Harry’s Flourtown, Pennsylvania, practice in a bidding war. Part of the deal, however, was that Harry would continue with the business to see it through to a stable transition.

This left Harry, who still owns a piece of the practice, with more free time and less control of his business, a trade-off many entrepreneurs confront after they sell their companies. For Harry, it’s been challenging to let go.

“It’s been harder than I imagined to have a backseat view to changes in the organization,” he said.

If he had it to do over again, Harry says that he would have arranged for a quicker transition out of the business so that he didn’t have to see it transform. “I kind of knew what I was getting into,” he explained, “but I didn’t know what it would feel like.”

Harry isn’t alone. For so many entrepreneurs, the hardest part of building a company is knowing when it’s time to leave it. No matter how ready you are to move on, it’s hard to say good-bye to a business you’ve put your blood, sweat, tears—and money—into building.

More often than not, there will come a day when it’s time to enter the next chapter of your life, whether that’s retirement or another passion or professional opportunity. When that time does arrive, you’ll want to be ready.

That’s why, for small business owners, as important as it is to think about how to start your business, it’s just as important to think about how you might one day transition away from it.

Building a Business Someone Else Could Run

We’ll level with you: Building any business is hard. Building one you can leave behind is even harder.

According to the Exit Planning Institute, 80 percent of companies with annual revenues of less than $50 million never sell—and just 30 percent of family businesses survive into the second generation. Meanwhile, many owners that do sell end up unhappy that they did.

When people can’t sell or otherwise transition their business to someone else, or when they are disappointed with the terms of the sale, it’s often because they haven’t created a business that’s ready to be sold.

Before you start thinking about transitioning out, you’ve got to be very honest with yourself. Look at your financial profile and consider whether another person could successfully run your firm. Is your business profitable? Are you well positioned in your market? Is the business growing and building market share? Is it durable? Can it scale up over time? If the answer to any of these questions is no, you’ll want to take the time to plan for and execute moves that will make your business more attractive to potential buyers.

Generally, the best acquisition targets share three—ideally, four—qualities. First, they’re profitable. Second, their assets are desirable. Third, their prospects for the future are strong. And fourth, they have something unique to offer. It might be a creative solution to a common problem, like technology or intellectual property. Or it might be something as simple as unique customer lists, an advantageous location, or other assets, like customized equipment.

Michael A. Sutherland Brown is CEO of Teamshares, a Brooklyn company that helps employees buy their companies when an owner retires. He sees digital businesses and those that combine physical and digital presences as very attractive to buyers. “Ninety percent of digital businesses are ones that owners can sell,” he says.

If that describes your business, make sure the world knows it, even if you’re not planning to sell the company anytime soon. Start networking. Let competitors and adjacent businesses know what you’re doing. One day, they may come to you with an intriguing offer.

Your networking should extend beyond the people and companies you think are logical buyers for your firm—especially when the logical buyers are in the same field. After all, a competitor might prefer continued competition to paying top dollar for your business, while someone who isn’t yet in your field might put a higher premium on the assets you’ve built.

Keeping Your Business in the Family

Many small business owners hope that their children will inherit and run their businesses, but as Brown puts it, “That option either exists or it doesn’t.”

“Sometimes families do run a business for three generations or more, but it’s very rare,” he explained. “The hardest things I’ve seen with children inheriting businesses are two difficult interpersonal dynamics: First, the founder has to let go. Second, the next generation has to want the business.”

These are difficult challenges, but sometimes passing a business down from generation to generation works out—as has been the case for Brooklyn, New York–based Acme Smoked Fish.

Acme Smoked Fish started in 1906 with Harry Brownstein, who delivered smoked fish door-to-door as a jobber on the Lower East Side of Manhattan. He bought smoked fish from several small smokehouses and delivered it to his customers. In 1954, he and his son-in-law opened their own smoked fish plant and decided to name it Acme—not only because that word means “the best” but also because they knew it would be one of the first businesses listed in the Yellow Pages. (In the era when Yellow Pages were relevant, that’s the kind of creative, smart thinking that helped a small business transform into a big one!)

Eventually, Harry’s great-grandchildren inherited the company. Four generations later, several of them still run it. They saw new possibilities for the firm, taking it from a small, family-run business to a global enterprise, says Emily Caslow Gindi, a co-owner and Acme’s customer service manager.

This growth, Emily says, can be traced in part to the fact that they had the foresight to upgrade their manufacturing capabilities. At the time, the investment felt like a risk, but it’s since turned out to be critical to the company’s ability to scale while prioritizing health and safety.

The current generation has had to navigate issues of equality—they own the company in equal shares—and fair compensation for each person’s role. Emily took time away from the business to raise young children while her brother and cousin kept working there. When she came back, they all decided it made the most sense for her brother and cousin to keep running the business. They recognized that an older sister reporting to her younger brother might get complicated, so they reworked their management structures, because as Emily says, “we’re committed to having our own adult relationships.”

That commitment has been vital to running a successful business with people who also spend Thanksgiving together. “The reason we’ve made it this far is that we’re family first,” Emily says. “We can be really mad at each other and totally disagree at work, but we treat each other well.”

That said, even with the best intentions—and working relationships—transitions within family-run businesses will always remain complex. No matter how you spin it, day-to-day interactions can be complicated when two people are both coworkers and relatives.

Keeping a business in the family can also make estate planning tricky, says Judith McGee, a financial planner in Portland, Oregon. It’s often difficult for business-owning parents to leave family members equal shares of an estate when only some of the heirs actually operate the business.

“It’s not always possible to make the inheritance fair,” McGee says, adding that she sees this with farmers and ranchers. “There might be a son who has worked with Dad and has his confidence. The daughters got married and another son went off and did something else. In many cases, the first son gets the lion’s share—and if he helped build the business, he thinks that he deserves to have what he created.”

Likewise, sales within a family can be difficult. Even if one or more children do want a company, they might find it difficult to pay what it’s worth. McGee herself is considering selling her financial-planning firm to a larger company, in part because her daughter and another minority shareholder don’t have the funds to buy her out. “They’d have to raise a significant amount of money,” she says.

Transitioning Ownership to Your Employees

Your employees could buy your company, either individually or as a group. This option can work well, but you’ll need a few pieces to fall into place. First, you, the owner, need to be willing to step down. Second, you’ll need one or more of your employees to be excited about running your business—and able to do it. And third, you’ll have to arrive at a price all parties can feel good about.

Brown, who deals with these transactions often at Teamshares, has seen that selling a small business to an individual is the most common arrangement. “The buyer is usually someone in her forties or fifties who doesn’t have a lot of expertise in buying or selling businesses. She might be getting an SBA loan and is probably offering 90 percent cash up front, which de-risks the transaction for the seller,” Brown says.

You could also sell your company to its employees through an employee stock ownership plan, or ESOP. To support an ESOP, a business needs at least 20 employees, and it needs to be successful enough to carry some debt, as it will either pay out the owner over a period of time, need to take out a bank loan, or rely on a combination of the two.

If you sell your company to an ESOP and the ESOP chooses to become an S corporation, the company’s income passes through to the ESOP—and since ESOPs are exempt, it won’t need to pay any taxes.

Without the burden of having to write a check to the government, the ESOP will have that much more money available to buy out the owner—otherwise known as you. There are many more pros and cons associated with selling to an ESOP, so it’s worth the time to research if the structure is right for your business.

Selling to Another Company

It’s also possible that another firm will want to buy your company. In many cases, it won’t come knocking on your door. You’ve got to do your own research. Brown recommends finding at least 50 companies that might want to buy yours. “You could work with an attorney to do this,” he said. “You could also do it yourself, if you have the time.”

Even if you do that research yourself, talking with an investment banker or attorney who specializes in advising small business owners about selling can be helpful early in the sales process. That’s especially true if you’re not familiar with how selling works.

A few tried-and-true tips can help you as you’re preparing for a sale.

Decide When You’ll Sell

Business owners typically sell when their personal timing, financial planning, and estate planning converge.

Like Harry, who sold his dentistry practice to another firm, many owners sell when they’re ready to retire. Others sell because their health makes it difficult to continue working as they age. Maybe their health is fine, but running the business is too stressful, or the business has grown past their ability to manage it, sometimes because market trends are moving away from an owner’s skill set.

Regardless of your motivation, you’ll want to plan a sale for a good time in the broader economy. Even if your company is performing well, you may find selling difficult if interest rates, your industry, or the overall economy aren’t trending to your advantage. Be mindful of these exogenous factors so that you don’t get stuck selling at the least opportune time.

Don’t Wait Too Long

You might imagine that you want to keep running the company for as long as its prospects are bright—but that sunny projection is exactly what will attract buyers and persuade them to pay a healthy price for your business.

Likewise, if you’re planning for a sale in a few years, but a seller materializes before your planned timeline, be willing to be flexible. A deal may not be there for you at exactly the moment you’re looking for it.

Run the Company

When you’re thinking seriously about selling your company, it can be tempting to mentally move along to your next step. Resist that temptation. You need to present potential buyers with a business that’s running at full strength. If you’re too busy with the sale, you can enlist a key employee to run the company for you, but either way, make sure it’s not slowing down precisely when you are trying to sell it.

Even if you’re planning to transition out, for as long as you’re at your company, run it as though you are going to stay there for the long term. There will be a temptation to skimp on what you invest into the business, as you ask yourself whether the purchase price will refund your investment. But if you cut corners, that will be reflected in the size of the offers you receive for your company. Additionally, a purchaser may want you to stay in place for two to five years after the sale to ensure a smooth transition.

Clean House

Selling is a complex process, and you want your business to be ready. Before you talk to potential buyers, clearly document your company. This is the time to create or update your capital structure, financial reports, and other records. Hiring an accountant—who might or might not be your regular accountant—to create orderly documentation will help potential buyers understand your business. Even if a business that’s under a drift of paperwork is actually in good shape, no one wants to buy a mess.

“You need at least three and ideally five years of clean, clear, professionally organized records,” Brown says. “QuickBooks is fine. Make sure you understand and can talk about the financials. Understand the cost of goods sold. Give accurate expenses and profit margins. People often imagine that they earn more than they do.”

If you’ve mixed your company with your hobbies or other parts of your personal life, disentangle them. Stop raiding the petty cash box when your wallet is empty. If your business is paying for personal expenses—anything from a car to magazine subscriptions—change the way that you’re funding these. If you’re running a sideline that’s part business and part hobby from the same books that you use for your main business, separate the two. Replace fuzzy boundaries with crisp lines around your primary business.

You cannot sell a business in which you perform every function, because without you, everything will collapse. If you haven’t already, begin building a team and processes that would help someone else run the company. Document the things you do.

Try to get long-term contracts or noncompete agreements with your key employees. Document any verbal understandings you have with shareholders and employees, especially with anyone who has invested money in the business or received ownership shares.

As you’re cleaning up shop, fix any problems that you find. It’ll put you in a better position to sell and forestall potential issues with a buyer. Buyers don’t care for surprises. There’s a market for imperfect businesses; indeed, this is the only kind of business that exists. But no one wants to reach a deal, only to be surprised. Try to discuss all your information about the business, eliminating or limiting last-minute hiccups. That improves the odds that the deal will close.

Negotiate a Deal

Make a complete, organized presentation to potential buyers. Focus on earnings and opportunities for growth. If there are multiple possible bidders, give all of them the same information at the same time.

Meanwhile, decide what you most want from this sale. Maybe you want the highest price, or maybe you care a lot about the next owner doing right by your employees or keeping the business in the same geographical location.

There are an unlimited number of variables that factor into every negotiation, so make sure you’re asking yourself questions from a variety of angles: Is this the right market for selling my business? Will key customers stay with the company if I sell? Do I have any potential deal-breakers in sale terms?

When the time comes to make your pitch, don’t state an asking price. Put out too high a number, and you’ll scare buyers away. Give a number that’s too low, and you leave money on the table. Let prospective buyers tell you what they think the business is worth.

Companies typically sell based on industry-specific multiples as a standard way to compare operating performance. The most common metric is multiples of operating profit, or EBITDA (earnings before interest, taxes, depreciation, and amortization). Advisors, attorneys, or people who have sold other businesses can give you a sense of the multiples that are typical for your industry. In addition to financial multiples, there can be operating multiples that inform valuation too. Operational metrics include price/active customers, price/recurring revenue, and more industry-specific metrics. These multiples let you create a mental estimate that you can compare against the offers you receive.

Keep in mind that money up front is just one potential element of a deal. You might take less money from a buyer who agrees to other desirable terms—like a shorter transition out of your role at the company. As Harry Taub discovered with his dentistry practice, staying on at your company after the sale can give you a little more control over how your assets are treated, but it’s not a perfect solution.

“If you’re selling your business, you need to be prepared to leave your business,” he says. “You might not agree with the new owner, and it will cause you a lot of agita to sit there and watch them change the business that was your lifeline. It’s tough to go from being the boss to being an employee. It would have been easier for me to leave earlier.”

A buyer also might want to pay you a percentage of the business’s performance after the sale to ensure that you’ll work hard to make the change of ownership a success. Called an earnout, this can be a bridge between the parties’ different estimates of what a company is worth. An earnout might be based on a product clearing regulators’ approval, for instance, or on the sales or profits from a particular product or piece of intellectual property. When this happens, the buyer is essentially asking you to hold the note while allowing them to pay you over time.

Alternatives to Selling Your Business

If you can’t find an outside buyer, or if transitioning ownership to a family member or employee isn’t working out, simply shutting down your business is a viable alternative to selling. It’s less lucrative, obviously, but it’s also much less complicated.

As a financial planner, Judith suggests that business owners avoid having all their wealth in their business. “Take some of that wealth out of your business during your working lifetime,” she says. “Under-live your income, take distributions, and keep your debt down.” When your eventual retirement and estate planning don’t depend on selling your company, you have more options.

Another choice might give you flexibility now and set you up well for an eventual sale: Hire someone to run the company and stay on as the owner. The person you hire could be an external hire or internal promotion. Either way, that person’s success depends on your willingness to move to a different role.

This strategy is rare, but it can be a good one, Brown says. It’s also a step toward a future sale, in that it shows that the business can succeed without you. “It buys back your time and makes your company super salable, while also taking the pressure off if you decide not to sell right away,” Brown says. “You might start another business, travel, or pursue a hobby.”

We know that when you’re starting a company, the last thing you want to do is think about how you’re going to leave it. For many of you, this chapter might not be relevant for decades. But odds are, there will come a time when you want out. Whether you sell your business, hand it over to a loved one, or shut it down, you should do so proud of what you built and prepared for whatever life has in store next.

After all, when you reach that point, you’ll have proven to everyone, most importantly yourself, that you’re a self-made boss in every sense of the word. Once you can say that, there’s not much you can’t do.

Let’s face it—sometimes things don’t always go as planned and entrepreneurs have to make difficult decisions on whether or not it is time to wind down their business. If you have exhausted all potential financing resources and there is no potential buyer of your enterprise, it may be time to adopt a more “defensive strategy” in order to mitigate personal liability associated with winding down your business.

First and foremost, you need to come up with a realistic assessment of how much runway you have to maintain operations. Unanticipated costs that can equal several weeks of operations can pop up during the wind-down process. Importantly, there are some expenses, like paying compensation or sales taxes and fiduciary duties to creditors, which if not satisfied as a legal matter prior to the wind-down of the business could result in director or officer liability. Getting ahead of these unanticipated costs is important and requires careful review of the company’s financial information with the advice of financial and legal counsel.

While the process can be daunting (and of course disappointing given the desired outcome), by partnering with counsel and other advisers you can take key steps to mitigate personal liability and make the wind-down process as smooth as possible.

Questions to Consider