The Importance of Transition Before Transaction in a Family Business

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.

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