How to Make Business Transition Planning Painless
Originally published on August 15, 2023
You’ve poured yourself into your manufacturing company, perhaps for decades. And now you’re ready to step back and enjoy the fruits of your labor. Whether you’re retiring, selling your business or passing it on to the next generation, planning for that transition is crucial to ensure its success.
Many owners wait until the last minute to begin a process that should start years in advance. A rushed transition can jeopardize a deal, leave your business undervalued or result in a leadership team that is unprepared to take over.
Mike Sibley, leader of the James Moore manufacturing team, and fellow partner and team member Kevin Golden share key steps to prepare yourself and your manufacturing business to transition well.
They discuss why transition planning is so important, what you need to be thinking about along the way, and how to get your financial statements and systems into shape to give a buyer the confidence they need to close the deal.
Transition can be sensitive
Letting go of your business isn’t easy. You already have the complexities of determining who will take the reins, how much the business is worth and how it’s going to persist in the future. Just as significant, however, business transition can involve a transition in your personal identity.
“Most business owners have grown their company from infancy, or maybe it’s been passed down from generation to generation,” Kevin said. “To think about not working in your business any longer – that’s just hard.”
Starting the transition planning process early gives you time to adjust to this identity shift. It also increases the odds that the transition proceeds smoothly and successfully.
Allow ample time to transition
Pain-free (and ultimately successful) transition planning takes time, so it’s never too early to start. Mike and Kevin offer three steps to get you out of the gate.
Step 1. Start talking about it.
This should happen at least four to five years before the actual transition. Start with preliminary, high-level conversations with the core group of people who must be involved in the transition process. This group might include key employees and/or family.
If you’re passing the business on to your children, start training them now so they’ll be adequately equipped to run all aspects.
“If a buyer comes in and they don’t see who can run the business without you there, that can potentially reduce the value of your business,” Mike said. “You need a leadership team in place that can give a prospective buyer confidence that the business will not only continue to function, but thrive.”
Step 2. Begin with the end in mind.
During the transition planning process, consider first how much you need to retire. For most business owners, their retirement is intertwined with the business itself. Calculate what the value of your business needs to be after taxes to continue to fund your current standard of living. If the estimated value at the time of transition won’t be enough, create a strategy to help elevate your business so it reaches that level.
Step 3. Spend some time reflecting on your “why.”
Why are you handing your company over to a new owner? The reason may vary by person and by business. Perhaps your goal is to attain the maximum payout possible so you can afford a comfortable retirement. Or your aim might be to take care of your employees or relatives.
“Start with that why. Then work your way to ‘What do I need?’” Kevin said. “Then ask yourself what you need to do today to start pointing you in that direction.”
These three steps will help shape your transition planning strategy. Once you have a strategy and end goals in mind, you’re ready to put your plan in action. This should happen at least two to three years before the business transition.
Increase the value of your business
Deals can fall through because a buyer balks at your financial statements and systems. Put yourself in the best position to sell by maintaining accurate financial reports and manufacturing data. Not only does this assist with transition planning, it can also help to increase the overall value of your company.
Analyze your business’s strengths and weaknesses for aspects that would give a buyer pause. Examine your customer concentration, management team, IT and financial structures. Pinpointing weaknesses and implementing solutions now will reduce risks and boost the value of your business at the finish line.
Look at your company through a buyer’s eyes
The best way to prepare to transition your business is to adopt the perspective of a potential buyer. So during your transition planning efforts, evaluate your company based on the criteria a buyer would use.
Here’s what a buyer will look at:
The last three years of financials: Buyers may even go back five to 10 years, particularly if this time period includes a recession. They will want to see how resilient the business was during an economic slump and how it bounced back.
The trailing 12: This is the last 12 months of financial reporting. A buyer will want to see growth in your net income and adjusted EBITDA, which stands for “earnings before interest, taxes, depreciation and amortization.” EBITDA is commonly used to measure the financial health of a business and its ability to generate cash.
Though it may seem counterintuitive, a record year may not be the time to sell. Buyers are looking for consistency to reassure them the business can continue to achieve the same level of net income. They will scrutinize your numbers at the monthly level, which is why making sure your accounts are reconciled is essential.
“It’s really important to not only look at a point in time, but to look how you’re doing over time,” Mike said. “Making sure you have good, accurate financial statements on a monthly basis gives a buyer confidence in the level of financial reporting and the due diligence.”
Inventory: In manufacturing, inventory is the single most important area of financial concern, particularly for a buyer. Ensure inventory quantities are accurate. Using cycle count procedures can assist in this without the time consuming impact of a full physical inventory. However, if this uncovers consistent large errors, look at your inventory systems or perform regular full physical inventory counts. Additionally, make sure raw materials prices are accurate and up to date and your labor and overhead allocations are appropriate.
An inaccurate inventory results in an inaccurate net income. It can also cost you two to three years to rectify inventory inaccuracies and create a solid trailing 12 months ready to present to buyers. So make a solid look at your inventory picture a key part of transition planning.
Financial systems: Whichever financial software system you use, maintaining accurate and consistent processes will allow someone to evaluate the numbers easily and feel comfortable interpreting them.
Kevin offers a “thumb in the air” test: Ask yourself whether there’s anything about your financials you currently don’t understand. If the answer is yes, you’ve got work to do.
“If you worked in the business for 20 to 40 years and still don’t understand it, I guarantee you someone from the outside is not going to understand it,” Kevin said. “It’s going to give them pause, which may lead to a lower valuation or a deal not going through.”
The bottom line: Start your transition planning now
Maybe selling your company is not top of mind for you at the moment. But you might unexpectedly receive an eye-popping offer that makes you reconsider. Don’t miss out on that opportunity by being caught unprepared, Mike advised.
Making these changes can benefit your business whether or not you are in a formal transition planning process.
“You may be 20 years out from selling – but these are things that can make your business more valuable now,” Mike said. “Generally speaking, if you’re making your business more valuable now, chances are you’re more profitable. And good financial systems give you more accurate financial data, empowering you to make better decisions.”
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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