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A transition is defined by Dictionary.com as “the process or a period of changing from one state or condition to another.” When most family business owners and their advisors think about succession planning or the sale of a business, the focus often becomes how to structure or transact “the deal”. The structure of any transfer of ownership in a business is very important and owners should have qualified advisors to help them consider the valuation, legal, tax, and financial implications of any deal. However, the value of a business is derived from its ability to generate and sustain positive cash flow. Therefore, before a business can have a successful transaction (sale or partial sale), it is important to have a successful transition. A business must focus on transitioning leadership, knowledge, and relationships and establish strong financial controls prior to the transaction taking place in order to maintain and increase the value (cash flow) of the business.

Leadership

In their book Built to Last, authors Jim Collins and Jerry Porras identified management development and succession planning as a key differentiator between visionary companies and their peers. These visionary companies often began planning for leadership transitions as soon as a new leader would start! For family businesses looking to sell or transition to the next generation, leadership transition is critical. Businesses must have a plan in place to gradually transition leadership responsibilities from the current generation (or leaders) to the next generation (or leaders) prior to a transaction. This will allow the business time to evaluate the new leaders and ensure a smooth hand off of responsibilities prior to the existing owners exiting the business.

Knowledge

Many family business owners have grown up in their business and know elements of the business better than their employees. Owners have critical knowledge that must be passed on to the next group of owners and leaders. This knowledge might include the history of the business, strategic planning, new product development, critical processes or systems, or understanding of the competition. These are pieces of information the next group of leaders or owners will need in order to continue the success of the business. Therefore, it is critical the knowledge is transferred from the current owner to the next group. This process will take time and should be planned out.

Relationships

Owners often have long established relationships with key stakeholders in their business. These relationships include customers, vendors, investors, lenders, and employees. However, these relationships could also be with key advisors, such as CPAs, lawyers, and consultants, or key community stakeholders. All of these relationships took time to develop and are important to the continued success of the business. Understanding that relationships take time to build, it is important the business develop a plan and timeline for transitioning these key relationships to the next group of leaders to ensure continuity and establish a process for educating the new leaders on the history of these relationships.

Financial Controls

Transactions are usually a leveraging event for a company. The company or new ownership takes on debt in order to buy some or all of the company from the previous owners. This increase in debt requires the company to have a strong balance sheet and sustainable cash flows in order to service the debt and the ongoing business. How can you ensure a transaction will be successful? Make sure the business has strong financial controls in place. These controls include regular, accurate, timely and relevant financial reporting, a 13-week cash flow forecast, separation of duties, and an effective finance and accounting team. These controls will help protect a business’ balance sheet and cash flow during and after the transaction.

The sale of a family business, to an external party or the next generation, is a significant event. The more a business focuses on transitioning leadership, knowledge, and relationships, and establishing strong financial controls prior to the transaction taking place, the better the chances of a successful transaction.

If you would like to discuss transitions related to family businesses, please contact us.

If you found this topic interesting, our strategic partner, JACO Advisory Group published content you may find relevant as well: Family Business Planning – Preparing the Next Generation to Lead and Who Should be Next in Line to Lead the Family Business?

Knowing the role of a Controller vs. a CFO

Controllers primarily focus on reporting and compliance in the finance and accounting areas. They manage and maintain accounting controls and related systems (the debits and the credits). Controllers also manage and/or produce monthly financial reports, year-end reports, and other financial reporting. Their responsibilities often extend to handling tax compliance for federal, state, and local income taxes, as well as payroll, state sales, and property taxes. These are essential components to strong financial controls, which are critical for the growth and success of a business.

A Chief Financial Officer, on the other hand, is primarily focused on the future of the company. They’ll use financial, operational, and sales information to plan and forecast, allowing them to provide the company leadership with the information necessary to make decisions around direction and strategy. Additionally, the CFO should be spending a lot of time ensuring that the business has excellent financial controls in place so the information that is created is timely, relevant, and accurate. Because of this focus on the business at a high level, the CFO becomes a powerful strategic partner to the owner and other business leaders.

Another important role for a CFO is to spend significant time on external relationships in an effort to provide the business with the best information and resources available. These can be relationships with professional service providers like the company’s Certified Public Accounting (CPA) firm, banks, legal advisors, and risk/insurance providers. These could also be relationships with specialty providers like outsourced IT firms, software programmers, HR management firms, or consultants. CFOs are also often asked to develop relationships with key community partners.

Knowing when to bring on a CFO

“When should we consider a Chief Financial Officer for our business?” is a question we are frequently asked by clients. For every company, it can be different, and our firm does a very thorough analysis of a company before making a recommendation, but here are some scenarios where adding a CFO can be incredibly advantageous.

Scenario #1 – When leverage is increasing
Having just a controller makes sense when a company has a strong balance sheet and low leverage. As the leverage increases, more care needs to be given to the balance sheet, forecasting, cash management, and external relationship management. This is where a CFO can help.

Scenario #2 – When business complexity or risk is growing
Perhaps your company is looking to acquire a business, implement a new ERP system, take on an equity partner. All of these events create complexity and risk for the business and require someone with strong financial and analytical skills to properly plan for the events, forecast the impact of the event, solicit the appropriate outside advice, and support the business. This is the role of a CFO.

Scenario #3 – When financial information is lacking
Often, as a business grows, the financial information does not keep up. Larger businesses often need very specific information or forecasts in order to make strategic decisions. Sometimes the business doesn’t even know what information it needs! Having a qualified CFO to anticipate and create timely, accurate, and relevant information to support decision-making is critical for businesses to grow.

If you still have questions and would like to talk, please feel free to contact us.

Tag: small business

The Importance of Transition Before Transaction in a Family Business