In the case of internal Business Transitions, I advocate businesses being “sold” to the next generation, not gifted nor inherited. This avoids many issues among siblings and family; it avoids multiple complications of “one of these days this will all be yours if you just do what I say”; and, often, the parents need the money for retirement. Sure, once the deal is done, bring in the lawyers and accountants to minimize taxes. However, in this case, a deal couldn’t be complete for two good reasons.
General is holding a staff meeting and the Captain interrupts. “Thank you,” the General says. A few moments later, the Captain interrupts again. Again, the General says, “Thank you.” When the Captain objects again, the General has had enough.
“Captain, you have a lot of objections.”
“Yes, sir,” the Captain noted, “after all, you didn’t get to be General by being a ‘yes’ man.”
“You’re right, Captain. But that’s sure how in the hell I made Major!”
For a successor to be a good General, they have to be an exceptional Captain first.
I was reminded of that during a recent visit. Dad, our General, hadn’t done everything right. He started things he didn’t complete. He had some good plans but didn’t implement. And he made promises that weren’t kept.
Nevertheless, he is our General.
The first good reason this transition couldn’t happen was simple. The parents don’t have the money to retire even if they got all cash today for what they business was worth. They must make the business worth more.
But Junior was anxious. He wanted to know now what he would have to pay and when will he be able to take over? That’s understandable but no one knows when this business will be worth more and when? It will happen when it happens.
The son sees a problem in that. From his view, he will work hard to build value which will increase the amount he will have to pay the parents.
That doesn’t make sense. Or does it?
The son overlooks the fact he is being paid $100,000 to do his job. For that, the business and the parents are entitled to his full effort. After all, if he were working for someone else, he’d would do his job and be happy to keep it.
Beyond that, the son should want to pay more. The value of a business is based on earnings. Typical multiple in our kinds of businesses is about 2.8 meaning the buyer pays 2.8 years’ worth of earnings to the seller.
If the business earns $100,000, the buyer typically pays $280,000. If the company earns $500,000, the buyer commonly pays $1.4 million.
Why should the son help the parents increase the value?
The son buys earnings. While he will pay less for $100k of earnings ($280k), he will also be earning $100,000. Pay more ($1.4 million for $500k of earnings) and he will be earning $500k after the payout. Either way requires him to work for the same 2.8 years for free. His choice is to earn $500k afterwards or $100k.
But there is a Second Reason this Business Transition Couldn’t Be Done
In this case, the son isn’t qualified to keep the job he holds now, let alone take over.
Why?
He doesn’t show up to work, so he’s not doing his job.
One has to be an exceptional Captain before one can be a good General. And failure to be at work when directed is a basic requirement to hold the job of Corporal, let alone Captain. Any owner related or not, is making a big mistake if they overlook that fundamental failure.
Premature Business Transition
“Premature transition” is where the topic of transition is raised and the successor immediately elevates himself to equal decision making power of the predecessor (owner).
The successor is never the equal of the predecessor because it is the predecessor’s money at stake. The only authority the successor has is granted to him by the predecessor(s).
So, regardless of how much a successor disagrees with a policy or decision or what the predecessor does or does not do, it is up to the successor to support and defend that policy or decision.
The successor may have input, of course. However that is limited to the authority given to him by the predecessor. Being selected as successor does not grant partnership status. It grants the authority that the predecessor(s) bestows.
The successor will never have equal or superior power over the predecessor, regardless of what the successor “knows” that the predecessor does not or regardless of how wrong headed any decision by the predecessor may be.
The predecessor is in charge of and responsible for the performance of the business until the business is no longer theirs. This means the predecessor should not “retire in place” or “coast.” They should remain an active part of management in, at least an oversight position. However if they don’t, it is their choice. After all, it is their money at risk.
A successor has an alternative should they vehemently disagree with a policy or decision of a predecessor: they may resign. Otherwise, they shall be supportive of the predecessor’s decisions and offer input as invited by the predecessor.
Yes, the successor must please the predecessor for it is the successor who is asking the predecessor to sell him the business. In this case the successor is asking the predecessor to loan him money so he may purchase the business. If the successor can’t please the predecessor; then there will likely never be a deal.
The owners must focus their energies on improving the value of the business rather than focus on “what if’s” involved in a theoretical transition. And that is best done through improvement of earnings over a three to five year period. Now, everyone back to work. There’s no deal to be made here, yet.
Are you planning an internal transition to someone in the business like a son, daughter or trusted employee within the next ten years? Or are you planning to sell the business? Either way, make sure you join our CPrint Silver program without cost or obligation and get our Cash In newsletter which focuses on retirement, transition, business value issues and more. Click over to https://cprint.com/silver/ and fill in the form. That’s all you have to do.
At CPrint, we assist owners with internal transitions as well as help get the business ready for sale through improving performance. Should you wish to have a no cost or obligation transition conference with me about your situation, email me at tom@cprint.com”. I’ll be glad to chat.
Tom Crouser
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