Succession Planning. On the Way to a successful Company Succession INTRODUCTION SPOTLIGHT 2018

Transcription

1 SPOTLIGHT 2018 Succession Planning On the Way to a successful Company Succession Introduction... 1 Principles of Succession Planning... 3 Company Succession within the Family... 6 Case I: Company Valuation... 7 Management-Buy-Out & Management-Buy-In... 8 Case II: MBI at Second Glance... 8 Case III: MBO backed by a Private Equity Firm... 8 Case IV: MBO with Bank Financing... 9 Sale to a Strategic Investor Case V: Sales Process Sale to a Financial Investor Cases VI: The Gradual Exit Closing Words Contact INTRODUCTION Company Succession in Switzerland Company succession is a subject of particular topicality and vitally important in the Swiss SME landscape. A study by Credit Suisse 1 suggests that by 2021, 20% of Swiss SMEs will be in the process of succession. Extrapolated over the whole of Switzerland, this affects more than 70,000 SMEs and relating thereto, more than 400,000 jobs. Demographic development suggests that the number of companies with succession needs will increase over the next 15 years. According to the survey, more than half of SME managers are now in the 50 to 65 age group. However, this "Baby-boomer generation" is facing a succeeding generation with a low birth rate, which is why a shortage of potential successors is emerging. 1 Credit Suisse Economic Research in collaboration with the Center for Family Business (CFB), University of St. Gallen: Credit Suisse (2016): Company succession in practice The challenge of generation change. 1/13

2 Macroeconomic Importance The previous paragraph illustrates the great importance of successfully implemented succession plans for the Swiss economy. A succession process challenges not only the entrepreneurs themselves but also all other stakeholders, in particular employees, customers and suppliers. A failure or an unsuitable solution has far-reaching consequences and may, among other things, jeopardize jobs, value, know-how and future taxable income. Possible causes of a failure are a sudden loss (e.g. the death of an owner) coupled with an unprepared and overburdened environment, a lack of funding, or simply the lack of a suitable successor. By contrast, a successful succession plan ensures the preservation of the lifework, assets, the interests of the different stakeholders and for family business, the peace in the family. Outlook The next chapter gives a general overview of the various aspects of succession planning and explains the different challenges, dimensions and options of company succession. In addition, the chapter also describes and illustrates the succession process with its individual phases. The subsequent chapters discuss the most common options, i.e. company succession within the family, the Management-Buy-Out (MBO), the Management-Buy-In (MBI), the sale to a strategic as well as to a financial investor, in more detail. The advantages and disadvantages for the entrepreneurs and for the company itself as well as the challenges and potential pitfalls are illustrated with specific practical examples. 2/13

3 PRINCIPLES OF SUCCESSION PLANNING Challenges Succession planning is a central task, which every entrepreneur must face sooner or later in the course of its entrepreneurial career. Finding a suitable solution involves many challenges. These are not only financial, organizational, strategic or legal, but also emotional challenges. Possible reasons are the existence of complex family constellations in a family business with a long tradition, the questioning of previous values and norms in the case of a change of ownership or the fact that the issue inevitably raises questions about aging and the life post company succession. Furthermore, it is about letting go one s lifework. However, good succession planning gives entrepreneurs the chance to secure their lifework and at the same time the prospect of tackling new professional or private projects. Five Dimensions of Succession Planning The challenges that arise in the context of company succession are often due to the complexity of the topic. The chart below outlines the five dimensions of succession planning. As a result, diverse design forms arise and thus, also a high complexity. The latter requires a holistic mindset and approach. Although every year many company successions are arranged, there are no general and readily available solutions due to the complexity and uniqueness of each situation. On the contrary, a tailor-made solution must be worked out for every single case. Chart 1: Five Dimensions of Succession Planning 2 2 Following Stiftung KMU Next (2014): Beratung ungleich Beratung Wann macht welche Unterstützung Sinn? 3/13

4 Wide-Ranging Succession Options With respect to the form, a distinction is basically made between company succession within the family and external company succession. Besides company succession within the family, the sale to the existing employees/management (Management-Buy-Out), the sale to an external management (Management-Buy-In) and the sale to a strategic or financial investor are common options of company succession. Moreover, there are other options such as an Initial Public Offering (IPO), the establishment of a foundation or finally, the liquidation. In addition, mixed forms are possible. However, the worst of all alternatives, is simply do nothing and thus, leave the future of the company to fate. Chart 2: Succession Options Succession Process A succession process is usually a one-time event in the life of an entrepreneur. Such an undertaking raises extremely demanding economic, legal (inheritance, marital property, pension), tax and personal questions. Thus, an independent and experienced sparring partner, who professionally accompanies the complex process, is of great advantage. The first element of each succession process is a systematic situation analysis. Based on this, various succession options are assessed. This procedure forms the basis for right decisionmaking and enables a solution that is tailored to the individual situation. It can take several years from first dealing with the issue to the implementation of a succession plan. The concrete process from the situation analysis to completion is in many ways similar to a generic company sales process with an average duration of six to nine months. How this process looks in detail, which process sections are emphasized more as well as the duration of the entire process depends strongly on the chosen succession solution. It has to be said that a sales process, in particular the phase of due diligence, is a very intense time for the owners and the management. It should not be forgotten to always continue the day-today business with care. Accordingly, taking into account the seasonality of the business, a definite time planning is essential. Besides M&A and tax advisors, legal consultants are always necessary while negotiating and drafting the transaction documents. Share purchase agreements and asset purchase agreements not only include the price and the terms of payment, but also regulates many other issues such as warranties, indemnities or non-compete clauses. In some cases, there are other issues that need to be negotiated, such as a shareholder agreement (which regulates, among other things, exit scenarios), a tax ruling or an employment or advisory contract. 4/13

5 Chart 3: Succession Process A succession process usually takes more time than commonly assumed. The day-to-day business often tempts entrepreneurs to put off the issue of their succession planning. The fear of the time afterwards, a loss of influence or prestige as well as the assumption that the company does not work without the own person, may play a role too. With the aim of value optimization, potential negative consequences for the company and its owners such as existing legacies, required restructuring and adverse tax implications should be identified as early as possible and be appropriately considered. 5/13

6 COMPANY SUCCESSION WITHIN THE FAMILY Prerequisites Able and willing successor Advantages Preservation of independence Gradual exit Disadvantages Conflicts of interest Potential challenges Objective decisions Inheritance considerations According to the Credit Suisse study, around 75% of all SMEs in Switzerland are family-owned businesses. This share has fallen compared to previous years. The study suggests the changing economic structure and social changes are possible reasons for the decline in the share of family businesses. If those causes are effectively responsible, a further decrease in the future can be expected. Nonetheless, family businesses will still characterize the Swiss SME landscape in the near future. In family-owned companies, the topic of succession planning is even more complex, because the family as an additional level, comes into play. The family's financial, personal and emotional ties with the company involve both opportunities and risks. Conflicts of interest and emotional rather than objective decisions can become a stumbling block and the inclusion of all participants is therefore an advantage. In the context of the situation analysis, so-called assessments are often carried out. They offer the opportunity to make a comprehensive overview and to clarify the ideas and expectations of each family member. A succession solution within the family offers the opportunity to ensure continuity in the company and to choose a gradual generation change. On the other hand, there is also the danger that new dynamics and new knowledge, which could flow-in by an external management, are prevented. Moreover, succession arrangements within family have the potential for conflicts between corporate and family interests, between generations and between family members. For example, the opinion about what is a fair solution can diverge strongly between family members. The application of different governance instruments (e.g. shareholder agreement, marriage contract, inheritance contract) in the run-up to succession can counteract the emergence of ambiguities and conflicts. There are different solutions within the family. One or more family members can take over the management, while the company ownership also includes further family members and thus, the managerial successors are at most minority shareholders. In a Family-Buy-Out, however, one or more family members take over both the management and the ownership of the company. The prerequisite for all options is first and foremost the existence of an able successor who is willing to take over the management. Depending on the family constellation, sufficient liquidity is required to pay out additional heirs, if there are any. In such a case, an independent company valuation should be used as a basis and the potential inheritance and its tax implications should be examined carefully. Financial feasibility therefore plays also an important role in a succession plan within the family. Of course, there are different ways how to find a remedy such as staggering of the purchase price, anticipated inheritance, a gift, a loan or the involvement of a financial investor. There is not always a suitable successor in the family and another solution must be sought. If potential successors within the family pursue other professional goals or do not meet the necessary criteria to run the company, but corporate control should still remain in the family, the employment of an external management can be considered. This alternative can also be used as an interim solution if the offsprings are still too young and can only enter the company at a later stage. In this case, sufficient attention should be given to potential conflicts of interest between external management and owners. 6/13

7 CASE I: COMPANY VALUATION The following initial situation was given: one of the descendants wanted to take over the company alone. The two other children had chosen other professional careers and did not want to be involved as successors, neither at management nor at ownership level. In order that the other children could also be considered adequately with regard to inheritance and that a fair solution for all family members resulted, the entrepreneur assigned Hitz & Partner to value the company. A business valuation is a complex undertaking requiring relevant expertise, experience, market intelligence and a strong data base. In the present case, detailed information about the company was first requested. In particular, the business plan was indispensable, which was checked for plausibility in discussions with the management. Various methods were used to determine the company value, such as the discounted cash flow method, the income and net asset value method and the market / transaction multiple method. The application of the different valuation methods resulted in an estimation of the company value, which served the family as an important basis for forthcoming decisions in the context of inheritance as well as the financing of the Family-Buy-Out. If no succession solution can be found within the family, neither at management nor at ownership level, there is a wide range of external alternatives available. The subsequent chapters deal with these options. It remains to be mentioned, that it is always worthwhile to have alternatives at hand despite the strong desire for a company succession within the family. 7/13

8 MANAGEMENT-BUY-OUT & MANAGEMENT-BUY-IN In the case of a Management-Buy-Out (MBO), the company is transferred to its own employees/management while in a Management-Buy-In (MBI), the company is sold to an external party who takes over the management. In practice, these options are often not considered from the beginning, although usually being very viable and promising solutions. CASE II: MBI AT SECOND GLANCE In this case study, succession planning within the family as well as the sale to a strategic investor were not under consideration. The reason was the owner's wish to see his company as an independent SME in the future. Apart from this, other considerations such as the interests of other stakeholders (e.g. employees) also played a role. Furthermore, it turned out that despite a capable management, the prerequisites for an MBO were not met. The situation prompted an external successor, who became shareholder of the company together with a financial investor in the sense of a Management-Buy-In while leading the company s management team. The successor was already working in the same industry and therefore, already knew the challenges of the industry, which greatly simplified the entry. With regard to the purchase price financing, an innovative solution was found, which enabled the external successor to build up a significant stake thanks to a cleverly chosen financing structure. Prerequisites Capable management willing to assume risks Strong cash flows The advantage of an MBO is that the management team is already successfully managing the company. Accordingly, continuity and independence can be preserved and the uncertainty of the various stakeholder groups is reduced, which is particularly appreciated by third party and equity investors. Overall, the process is slightly different than if the company is sold to a third party. On the one hand, the management already knows the company very well. On the other hand, bank financing is not equity financing and thus, due diligence is rather similar to a credit check. The existing relationship of trust between the parties coupled with continuity may facilitate the transfer on an emotional level. The most important prerequisite is that the management has both, the necessary skills and the willingness to take risks. CASE III: MBO BACKED BY A PRIVATE EQUITY FIRM Hitz & Partner was mandated by a company owner in the course of a MBO. The company had a subsidiary abroad. Both companies were led by strong management teams and the owner was not fully operationally involved anymore. However, the entrepreneur was largely available to the management in strategic matters and still maintained some important customer relationships. An analysis of the situation revealed that selling the entire group to the management team, consisting of members of both companies, was problematic for two reasons. Firstly, management teams of the domestic and foreign companies had worked independently of each other, sudden joint ownership would not necessarily be easy. Secondly, the funding should have been done through own funds from the management team and through funds from a private equity investor. However, financial investors rarely invest in different geographic markets. In accordance with the situation, the subsidiary was split off and a separate MBO with significant private equity participation and vendor loans respectively was realized for each company. 8/13

9 Advantages Continuity No disclosure of information to other market participants Disadvantages Financial burdens for the management High debt financing Potential challenges Transition from employee to entrepreneur Potential conflict of interest between management and owners Efficient tax structure (e.g. Indirect partial liquidation ) One of the challenges of a Management-Buy-Out is the successful change of roles from employee to entrepreneur, which does not always happen automatically. There is also a certain risk potential for conflicts within the management team as well as for conflicts of interest between the owners and the management team. The management team is suddenly an independent party and takes over the view and interests of a buyer. Potentially, this may result in a less loyal management to the owners and put the relationship of trust to the test. Therefore, it is helpful to clarify circumstances as early and transparently. As the management team is an independent party, the question arises as to which consultant is necessary for the management. With an increasing number of parties involved in the process (sellers, management team, private equity investors, banks, etc.), the number of consultants typically also arises. This can prove to be inefficient. It can prolong the process unnecessarily, incur extra costs or in extreme cases even become a deal-breaker. From an operational point of view, the management team knows the company best, which has to be taken into account when selecting advisory services. On the other hand, it is undisputed that legal and tax advisers who represent the interests of the management team are indispensable. In a MBO, the biggest challenge normally is financing, because management usually does not have enough financial resources to finance a purchase price. There is, however, a whole range of financing options, whether in the form of debt, equity or mezzanine capital (hybrid between equity and debt) that can be considered. Investors may be banks, private equity investors or the sellers themselves. When structuring the financing structure, the respective tax implications of the various parties must also be carefully examined (e.g. indirect partial liquidation of the company). Important for the financing is therefore that the company is well positioned and has high cash flows which is a precondition for the management team to obtain and amortize a bank loan. Furthermore, it is important to ensure that a healthy and for the company sustainable financing structure is chosen. High levels of debt can become a problem for the company, if there is no longer sufficient liquidity due to a lack of equity. Unless sufficient external financing is possible, the owner may provide a vendor loan with reasonable terms. CASE IV: MBO WITH BANK FINANCING This case study is about a company with a long family tradition. However, for the next generation change a succession plan within the family was not in prospect, which is why Hitz & Partner was mandated. While evaluating various succession options, Hitz & Partner and the owners concluded that a Management-Buy-Out would be an obvious choice. The situation was optimal as there was a strong management team and the company was developing very well. Typically, the critical issue in this Management-Buy-Out was the funding of equity, lacking financing management s own resources. Therefore, various financing options including bank financing were examined. One option was that the sale price would have been partially funded by the bank, the management team itself as well as a vendor loan. Due to tax consequences, the idea with the vendor loan was rejected and the transaction was finally structured with put and call options. As a result, the final financing solution was financially viable for the management team as well as for the company, which ultimately enabled the transaction. 9/13

10 Prerequisites Readiness for a complete sale A suitable purchaser needs to be available SALE TO A STRATEGIC INVESTOR The sale to a strategic investor is also a common, even though the most definitive form of company succession as generally 100% of the shares are sold. The acquisition of a company, including know-how, products, customers and markets can be of great strategic interest to the buying company so that it can further develop its business. In this context, it is always necessary to weigh up possible synergies and dissynergies. CASE V: SALES PROCESS In this case, the direction for the owners of a company was relatively clear. The owners, who were still partially active in the business, wanted to sell the company as there was no entrepreneur available. Thus, they mandated Hitz & Partner to handle the entire sales process. As a first step, the sales process included the development of a business plan and drawing up of the Information Memorandum (IM) as a basis for potential buyers while evaluating a possible acquisition. A number of potential buyers were identified and addressed. They had the option of submitting a non-binding offer. Two interested parties were selected and approved for the subsequent due diligence phase. The early involvement of the management team is favorable as they will have to run the Management Presentations. After submitting the "Firm Offer", the owners decided to grant it exclusivity for three months to one party. This was followed by the second phase of "Confirmatory Due Diligence", in which more sensitive information was disclosed. At the same time, the transaction was structured while negotiating and drafting the transaction documents taking into account tax aspects and the sales contracts were negotiated. Following the sale, the former owners acted selectively as consultant to the new owners during a period of 12 months following completion aiming for a smooth handover. Advantages Market price is achievable Realization of synergy potential Disadvantages Gradual exit is not always possible Potential challenges Uncertainties among stakeholders (in particular customers and employees) Integration problems The sale of the company to a strategic investor is attractive, because the company can normally be sold for a market price at the desired time and because inheritance issues can be handled easily. Among other things, the competitive situation in the course of a limited auction positively impacts the purchase price. Nevertheless, resolving potential weaknesses and existing legacy issues are prerequisites for a successful sale. Both, a financial but also a strategic investor open up new development perspectives for the company. The advantage over a financial investor is that the strategic investor is well versed in the respective business area and, if necessary, can also bring in synergies. However, there may also be uncertainty among the various stakeholder groups, such as the fear of a possible job reduction. In addition, there may also be integration problems, for example when dealing with different corporate cultures. Professional support coupled with the necessary industry experience and the selection of a suitable buyer are therefore crucial. Even with this option, the momentum is not negligible. As soon as a quick solution has to be found, the time pressure can seriously affect the negotiating position. 10/13

11 Prerequisites Appreciation potential Strong Management Advantages Gradual exit Growth financing Disadvantages Focus on exit High leverage for the maximisation of the return on equity Potential Challenges Alignment of Interest SALE TO A FINANCIAL INVESTOR A financial investor invests for a period of typically 5 to 7 years. To incentivize the management, it gets involved with a low equity holding (so-called sweet equity). Important prerequisites for a sale to a financial investor are i) an existing appreciation potential of the company and ii) a strong management team. The sales process is almost identical to the process in the case of a sale to a strategic investor, although a financial investor typically becomes absorbed in the due diligence process lacking experience in the trade. A slight difference lies in the disclosure of the documents. Since in the case of a financial investor the sensitive information is not directly addressed to a competitor, the information in the due diligence can usually be disclosed more transparently. For a strategic investor, a clearer grading is normally necessary, especially if the first phase of the process includes several potential buyers. The sale to a financial investor may require a reinvestment of the seller, especially if the future management should still be supported for a certain time by the previous owners. Thus, participation by a financial investor supports the continuation of independence and the company gets the opportunity for further expansion. CASES VI: THE GRADUAL EXIT The sole owner and manager of a company dealt with her company succession at an early stage because no one in her family wanted to get involved in the company. She wanted to secure the continued existence of the company and still influence it as far as possible. To put her plans into action, she appointed Hitz & Partner. It became apparent that a private equity investor would best meet her expectations of an ideal succession arrangement. She continued to be the managing director, reinvested parts of her proceeds and became a minority shareholder. Thus, she was able to sell and at the same time she gets enough time to gradually hand over management to her successor, a situation ensuring the continuity of the company. 11/13

12 CLOSING WORDS The article and the different practical examples demonstrate how diverse and complex the process of company succession can be and that there are no standard solutions. Different business fields, legislations, ownership structures, family constellations, personalities and objectives require different approaches and solutions. An optimal company succession requires a tailor-made solution in each case. Nonetheless, there are a few points that apply in principle to all entrepreneurs dealing with company succession resulting in the following five recommendations: Deal with the issue as early as possible and start planning at an early stage and in a structured way. This prevents unnecessary time pressure and a sale below value. Always check several alternatives. Considering that the desired company succession is not always feasible, you increase the chance for an optimal succession solution. Bring in experienced and skilled professionals. This will ensure that all important aspects of the complex issue are adequately addressed and allows you to continue to focus on the day-to-day business. Involve key people in the process at an early stage and make the communication to all stakeholders proactive and transparent. In this way, you promote the acceptance of the solution and increase the chances that everyone supports the chosen succession plan. Have a look at life after your entrepreneurial career, even if the thought of a new chapter in one s life may be require getting used to. 12/13

13 CONTACT Stephan Hitz Managing Partner Swiss Certified Public Accountant Cédric Diego Vollmar Partner Master of Science in Banking & Finance HITZ & PARTNER CORPORATE FINANCE AG Münzgasse 6 CH-6003 Luzern Phone: +41 (0) Fax: +41 (0) Hitz & Partner Corporate Finance AG, Lucerne, /13