You did the research, wrote the business plan, obtained the funding, completed the paperwork, opened the doors and christened your business.
You planned and executed, analyzed and steered that business. You hired employees, created a culture, fostered an environment of success. All along the way, you tracked its progress and watched it grow. It’s your baby.
Suddenly, it’s time to retire. Time to loosen the reins to find out what all those long hours and all that hard work have amounted to.
A clear path
Several months ago, Mike Erwin began allowing his second-in-command to run employee meetings while he sat in the front row and quietly mentioned points to cover. He moved further back in the room at each successive meeting until he was loudly heckling Jeff Kerlin from the back row. That’s when he knew it was time for him to leave the room.
Erwin, who recently retired from his role as chief executive officer of Menomonee Falls-based label manufacturer Tailored Label Products Inc., planned the move many years in advance.
“I wanted to retire in kind of a normal cycle of 63 to 65, and be able to have the energy and enthusiasm to do other things,” Erwin said.
About 10 years ago, he began aggressively expanding the size of the company both organically and strategically. In 2005, TLP acquired Engineering Label Products, a company started by Kerlin and Tracy Tenpenny. Both Kerlin and Tenpenny came on board at TLP and in 2013, Erwin and his co-owner sold part of TLP to them.
Kerlin moved up the ladder over the years, and he and Erwin communicated often about the succession plan.
“You’ve got to have the hit-by-a-bus option,” Erwin said. “For years, it was described as ‘If Mike got hit by a bus, Jeff’s there.’”
About four years ago, the two started the leadership transition process, seeking the advice of peers and bringing in a high-level executive coach to guide them.
“It’s just healthy to have a third party behind the scenes to facilitate discussion,” Kerlin said. “We agreed as much as we disagreed, but we did it in a healthy way.”
In May 2013, Kerlin was appointed chief operating officer. In February 2014, he added president and partner to his job title. And on January 1, Kerlin was named CEO as Erwin retired.
Through the succession planning process, Erwin strengthened his bench to include three potential successors, one of which is an early successor to Kerlin after his tenure ends.
The pair spoke monthly about whether Kerlin was ready to take over and which work could be taken off Erwin’s plate and put on his.
“It’s hard. He’s been chief poobah a long time,” Kerlin said. “I said, ‘Don’t confuse my loyalty to you to not wanting to take the reins of this company.’”
Eventually, they set an official date and began working with attorneys to modify the ownership documents and employment agreements. They got the board’s consent, and then informed employees of the transition date. They were mostly unfazed, since Kerlin had gradually and explicitly been taking on Erwin’s duties.
Erwin’s still around the office frequently, and serves as an on-call advisor for Kerlin as he forges ahead.
An owner’s retirement should be planned well in advance – maybe as far out as 10 years, like at Tailored Label, said Shawn Govern, an attorney at DeWitt Ross & Stevens in Milwaukee.
Among the considerations to take into account: Tax implications; family dynamics; business liquidity concerns; business owner payout; relationships with customers, suppliers and employees; and corporate governance.
It can be difficult to decide when would be the best time to retire. There’s a psychological aspect to letting go of the company you built and associate closely with your identity, said Dave Vetta, president at First Business Bank-Milwaukee.
“Getting something out there in terms of a timetable or some objectives they want out of retirement or from the business, that’s an important point,” Vetta said.
The business could be sold to management, to the next generation of the owner’s family, to a strategic buyer or to a financial buyer. It could be that the business closes and the assets are sold. Maybe the employer forms an Employee Stock Ownership Plan to pass the company on to all of its employees. Or perhaps the leader remains part owner, and either recapitalizes the business or transitions out of the company and into retirement.
There are a variety of options available, but the best one won’t be clear without careful evaluation, Vetta said.
Leaving time to sort things out is critical. If a sale is involved, it can take more than a year to complete the due diligence and acquisition, let alone the time the owner should put into preparing the business to be put on the market, said Paul Griepentrog, an attorney at Godfrey & Kahn S.C. in Milwaukee.
With several years’ notice, the company can get its house in order and the business owner can create an updated estate plan, he said. The owner should clean up internal and corporate records, locate critical contracts, and shore up customer and employee relationships.
Then, after the pre-planning and preparation phase, the actual sale process can really begin.
People don’t like to think of their own mortality, so it can be a challenge to sit down and write out a succession plan, but it’s a good idea, Govern said.
Many people plan for retirement or death, but they often do not account for disability or separation of employment. A carefully evaluated succession plan can clearly lay out the procedure if one of these events occurs, Govern said.
“The whole process of succession planning is much better to be done when they control the circumstances, rather than the circumstances controlling their decisions,” he said.
If the owner or his spouse were to receive a serious health diagnosis, the timeline could be accelerated, said John Emory, Jr., president of investment bank Emory & Co. in Milwaukee. But the owner will need to keep working for at least another 12 months before exit if a sale is in the works.
If current managers will be a key part of the business after the sale, having a few years of lead time can allow the business owner to develop the leadership team and help it rise to the occasion, Vetta said.
“You might want to explore who might be potential buyers,” Vetta said. “How closely does it align with the owner’s objectives and what’s the right avenue?”
Preparing to sell
It’s important to be realistic about the value of the business, and engaging an advisor such as a banker, broker or lawyer can help set expectations, said Kent Velde, president of private equity firm Lakeview Equity Partners LLC in Milwaukee.
“For most owners, when they sit down, they’re looking for a cash deal,” Velde said. “Normally, an offer would include minimal cash and can often include a note and potentially an earnout.”
A sale to a private equity firm can provide immediate liquidity, and can also offer an opportunity to remain a minority owner and/or a member of the board or management team.
“The continuing minority ownership provides the potential for further value creation for the business owner when and if the private equity firm exits – normally four to seven years,” Velde said.
Planning is an important aspect of getting the best value, he said.
“There’s no question that if somebody’s thinking about this, they should be doing a lot of advance planning,” Velde said. “They should be working with an advisor to prepare the company for sale. This is not just something that happens overnight.”
It should be possible for the owner to extract herself and for the company to continue functioning in her absence with a strong management team. That gives buyers confidence, Emory said.
If the business is being passed on to a family member, the owner should consider how much money she needs to finance her retirement, and balance that with giving the family member a good deal, he said.
“Our view is always that you want to have a good mix of strategic buyers and financial buyers that you’re talking to,” Griepentrog said. “We think it gives you the clearest sense of value. It gives you a good range where you can really get an understanding of the true value of the company.”
“If it is going to be a family member, how do we set up the corporate governance so that they can grow into their responsibilities?” Govern asked. “That can be very critical. Otherwise you can have upheavals of management.”
Often, a business owner will transition into a chairman role while the child becomes president or chief executive officer, so they can set up an advisory relationship as the owner heads toward retirement, he said.
Weighing the options
Let’s say the business owner doesn’t have children or his children are not interested in taking over the company. At the same time, there isn’t a clear leader in the current management team. In such a case, an Employee Stock Ownership Plan or an asset sale can make sense.
“An ESOP in that circumstance is likely to be a very effective way for those key employees who have been with the business to take over the business and then fund his retirement as he departs,” Govern said.
At Milwaukee-based Hatco Corp., an ESOP was the best way for the former owner, David Hatch, to retire. His parents started the company, he bought his brother out years ago and he had no children.
Hatch wanted to retain the family legacy, keep the company where it was and reward the employees when he retired in 2004, said David Rolston, president and chief executive officer.
“He had made up his mind 10 years before that this is what he wanted,” Rolston said. “He considered us family and he really was a great guy to work for. He had developed a tremendous culture to begin with, so we didn’t really need anything fixed or turned around.”
Hatco’s 470 employees purchased 49 percent of the company in 2004 through the ESOP plan, and in 2007 bought the remaining shares, Rolston said.
“Selling to someone who would move the factory or not treat the employees well is just something that (Hatch) would not even want to consider,” Rolston said. “There’s tax benefits selling to an ESOP and a lot of that’s complex, but the result is that you get a fair market value.”
An asset sale comes into play with small businesses that don’t necessarily have a high value to a third party, Emory said.
“Sometimes a small service provider, when you retire, you may try to transfer your existing client relationships to another small firm and maybe get some kind of fee over time,” he said. “One thing to think about is, is your business saleable to a third party or do you need to sort of groom your internal buyer?”
Deb Teglia, owner of Oak Creek-based asphalt company Black Diamond Group Inc., succeeded her father in leading Black Diamond.
She spent 40 years working in the business, and one day in June 2015, she realized she wasn’t having fun anymore.
“As an entrepreneur, you work hard on your business. You’re in it to win it,” Teglia said. “I was reaching a realization that I, and I saw in some of our employees, we didn’t have the same passion for what we did.”
In the construction business, there aren’t a lot of total company sales since there has been a lot of consolidation and the equipment is usually the most valuable asset. After consulting with trusted advisors, she decided to complete an asset sale and close the business.
Black Diamond completed the construction season in November, informed customers and its 28 employees, collected its receivables, paid its bills, and sold the real estate assets in December and about 200 pieces of equipment in January.
Teglia, 61, is now the only employee, and plans to close the doors in late summer or early fall. Then, she’ll take a much-needed vacation and evaluate what to do next.
“I also had the care of a loving family and great friends to put it all in perspective, because your business is your baby and after nurturing it all these years, it’s hard to let it go,” she said. “The stress was at the beginning. The stress was making the decision and confirming with myself that it was the right decision. If you’re going to decide to do it, just do it and move on.”
There are several benefits to selling the business to an internal candidate, such as a family member or an existing employee.
It’s the most confidential transaction, and the transition is usually easier, Emory said. Due diligence is much easier, as well. There’s also the moral benefit of helping a family member or rewarding a loyal employee, Emory said. On the other hand, the internal buyer does not usually have a large store of cash, so the purchase price will likely be lower and the transaction is not likely to be all cash.
The owner can train that person and prepare him for the transition, gradually releasing control.
“If you have a lot of time, you get enough ahead of this and the company is on a growth trajectory, then all of these things work in your favor,” Vetta said.
From the bank’s perspective, the new manager needs to be vetted and the updated business plan needs to be evaluated before the transition, he said. It’s important that the new owner is not overleveraged, and has some of her own skin in the game.
“That new leadership team has to be evaluated very closely and almost like it’s a new deal,” Vetta said. “There’ll be elements of a new business plan, there’ll be projections, they will have some changes in mind.”
A strategic buyer, on the other hand, usually pays a higher premium, which may be competitive with a private equity firm’s offer.
The strategic deal has the most confidentiality risk, because of the in-depth due diligence process that could open up the company’s inner workings to competitors. There’s also the matter of the business owner’s legacy, if that is a concern, Emory said.
Selling to a private equity group is most likely to result in a large influx of cash. An owner could choose to sell 100 percent right away, or sell a portion of the business and then come back for a “second bite of the apple” once the private equity firm resells it in five to seven years.
The seller should consider an operations consultant if there’s enough time, as well as an M&A attorney, a size-appropriate investment banker and a respected
“The most important single factor is your trailing 12 months’ profit before sale,” Emory said. “So really protect and try to grow those profits. Do not do something that is going to hurt those profits.”
Think of your family
If a business owner passes away without having created a succession plan, the company passes into probate, which can be a lengthy process for family members.
“A sale of an asset out of probate is not going to be the best way to maximize the value of that business,” Govern said. “It’s kind of like a sheriff’s sale in some regards. It’s a distressed sale.”
In some cases, the process is not as cut and dry. If the deceased leader only owned part of the business, her shares may not be saleable, and the surviving family member could end up in an unplanned business partnership with another owner, Govern said.
Or, it may not be clear who the business owner would have designated as the beneficiary of his shares, which could open up the door to litigation among his surviving relatives.
Rarely does anything good happen from an owner dying without a succession plan, Vetta said.
“What happens is if they’re not prepared for that, the company could suffer, the valuation could suffer, the family or the leadership could have infighting and not be on the same page to be able to extract the value of the company,” he said. “You end up having a fire sale. The equity that the owner worked so hard to grow over 40 years, it’s a shame when that’s not maximized.”
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