Who should be reading this?
Business owners who would like a better understanding of:
- The mechanics (legal and financial) of transitioning a business,
- Timeline considerations – when to do what,
- What are the different models for business transition; and,
- What are the resources available in the region?
What is a transition?
A business transition occurs when the ownership of a business is transitioned to another party. This can be a very simple process at times, but it can also be complicated due to the existing ownership structure; or the structure to which the business is transitioning. The bottom line is that a business transition is the legal and financial transfer of a business’ ownership from one entity or individual to another.
Why transition a business?
There are many answers to this question. A few, common and basic, answers are provided herein. For the seller, a transition is often a liquidity event which means that they are able to gain monetary value from what they have built. Moreover, the business is able to continue operating in the community and will remain an economic force as an employer and tax paying entity.
For the buyer, oftentimes the acquisition represents an opportunity to purchase an operating asset. To use an accounting term, it’s a “going concern” which means the business has been generating revenue for a long period of time and will, most likely, continue. It is much less risky to acquire a “going concern” than it is to start something from scratch. In some ways, one could view the acquisition of an existing business as a way to, essentially, buy your own job. For many, being self-employed is very attractive from a career and lifestyle perspective.
Also of note, business owners who are ready to sell, often find themselves operating the business passively. That is, the “spark” that initially attracted them to self-employment, or the business, has diminished. The desire to chase emerging markets and mediums has dissipated. This can represent a great challenge for an entrepreneurial new owner who can see new growth opportunities.
What are the types of transitions?
For the purposes of this post – we will keep things simple! Subsequent posts will have more detail about the different types of transitions. There are three main types of transitions:
- Third party – when one party purchases the operating business from another,
- Transition to a worker-owned cooperative – A worker cooperative is an employee-owned business where each member (worker) has one equal share of the business. This also means that every worker-member has one equal vote in the co-op–no matter their pay or how long they’ve been a part of the business. They are democratic businesses in nature, (https://cdi.coop/); and,
- Transition to ESOP – this is typically achieved using Employee Stock Ownership Plans (ESOP). An ESOP (employee stock ownership plan) has a completely different ownership structure. In this case a separate entity, a trust, acquires some portion, sometimes all, of a company’s stock, and holds it for the benefit of employees. The company generally appoints the trustees who administer the plan, which is largely a retirement or separation benefit. Employees’ accounts within the trust accumulate shares of the company based on various formulas, usually based on salaries as well as the pace of the company paying back bank loans for the purchase of company stock. The value of the shares at any given time depends on an annual independent valuation of the company. Typically, employees receive the cash value of the shares in their account upon leaving the company. They never directly own the shares and only under rare circumstances can direct how those shares get voted, (https://cdi.coop/).
Sellers, find your path!
Transitioning a business will take time. It can be a three to five year process. Only you, the owner, can decide how and when to do this – but it’s very important that you start the process the earliest. Even if you think you’ve got some time, there will be nothing lost by educating yourself about the various considerations presented above. You will also need to reflect on your financial goals, meet with your team – your legal counsel, accounting / bookkeeping provider, and personal financial advisor. There is often a gap between the owner’s perceived value of their business and the market. If you start now, however, you can better prepare yourself and the business so that you can meet your desired outcomes.