By Maurie Cashman
Ownership transition planning takes communication, time, initiative and experienced professional advice which, done effectively helps to continue the growth and success of the company both during and after the transition. However, be sure to be aware of these twenty common mistakes
1. Financial Obligations. Financial obligations to retiring partners are created without adequate cash flow to service those obligations or obligations are taken on under the assumption that the new owners will assume these obligations. The new owners and the obligation holder (the bank) may not be willing to release these obligations.
2. Recapitalization. Firms fail to consider the option of recapitalization with a limited liability or other form of pass-thru entity to make a transition plan more affordable and to minimize the tax burden at sale.
3. Failure to Value the Business. Owners take the first step in ownership transition planning without an independent calculation of the value of the company by an outside firm. As a result, owners cannot find buyers at the value they expect.
4. Not Protecting Against Competition. Firms fail to understand the value of covenants not to compete to prevent the loss of existing clients, suppliers and information upon departure of employee-owners and key employees.
5. Waiting Too Long. Planning occurs too close to the retirement of the owners AND key management of the firm, leaving insufficient time to train successors. This happens often in companies that are held for long periods by an individual or individual family, who tend to treat their employees like family. If this occurs you may also lose ability to sell to outside third parties, who may simply â€œwait you out.â€
6. Failing to Recognize Talent. Firms fail to recognize the potential of existing employees to transition into management and business development. As a result, the firm may be dissolved or sold for a fraction of its value during its prime.7
7. Not Protecting Key Employees. Key employees are not allowed to gain ownership until they are in their forties. As a result, talent may not be bonded to the firm and may leave for other firms where the possibility of an ownership position occurs earlier in life.
8. Lack of Communication. Future owners are kept out of the planning for ownership transition. As a result, owners are disappointed when employees choose not to purchase ownership interests. Employees are smart, they know you have plans for the future, or they assume you do. If they sense that you donâ€™t, it can be very damaging to morale and may cause key employees to look elsewhere. This must be carefully balanced against confidentiality concerns and only those who need to know should be a part of the process and only if they are covered by proper employment agreements.
9. Inadequate Use of Retirement Plans. Tax-advantaged retirement plans, such as pension plans, profit-sharing plans and non-qualified deferred compensation plans are not considered as a funding source for an eventual buyout under a buy/sell agreement.
10. Failure to Use Professionals in a Sale. Firms may determine in their planning process, or even change their mind in the middle of the process, to look to outside purchasers. They usually donâ€™t understand the problems that can be created by claims made professional liability. As a result, former owners may have to buy â€œtailâ€ insurance or be responsible for deductibles for claims caused by the merged firm. A firm that is properly qualified, reputable and experienced will help to avoid these claims and will have insurance that provides an additional level of protection. You should understand that realtor insurance does not typically cover these liabilities.
11. Failure to Incorporate Into Strategic Plan. Ownership transition is not considered a part of a strategic planning process.
12. Lack of Disability Coverage. Firms fail to fund buy/sell agreements to purchase stock upon disability with disability buyout insurance.
13. Not Tying Ownership to Performance. Ownership interests are distributed as compensation perks rather than to encourage key players to participate in management that causes the firm to grow and increase in value
14. No Buy-Sell Agreement. If there are multiple owners and there is no buy/sell agreement dealing with death or disability, ownership will pass to the estate of the deceased owner, reducing the estateâ€™s leverage to negotiate a sale with the remaining owners
15. Fear of Opening the Books. Ownership transition planning is delayed because owners donâ€™t want to allow employees to look at financial records.
16. Lack of Management Skills. Ownership doesnâ€™t change except for the death, disability, or retirement of existing owners. No plan exists for gradual admission of new owners and, as a result, they may lack the management skills to continue the firm.
17. Owners Feel Indispensible. Clients like to see younger generations being prepared for management because it assures the client of uninterrupted service. Older owners must understand that the cemetery is filled with indispensable people. I have seen major long term agreements with third party companies that contained change in control provisions that voided the contract if certain key non-owner management left the company.
18. Taxes to Employee Buyers. Ownership interests are given to employees without requiring payment. This usually causes unexpected taxable income to the employee based on the value of the interest. What needs to be clearly understood is whether or not dividends are going to be paid to employees to cover taxes or whether the employee will be expected to cover them. This includes Payroll and state taxes.
19. Sweat Equity. Founding owners often believe that the value of the firm should reflect their â€œsweat equity.â€ Usually there is no basis for such an assertion. This is a business transaction.
20. Use of the Wrong Advisors. Firms sometimes use attorneys and consultants who are primarily involved in serving asset-based companies. These advisors may not understand the special needs of professional service firms. The opposite also occurs. A firm may also use an advisor that has been with them for a long period. These advisors may not specialize in ownership transitions or transactions.
These issues can all be identified and overcome by a qualified team of advisors or they can destroy a company, and the Cashflow you need to move on if your advisors are not committed to handling this on a dialing basis.