Choices in Succession Planning and Partner Buy-ins

Who doesn’t like having choices when deciding on something as important as selling their business? In a recent podcast and webinar (respectively), Oak Street Funding President Alicia Chandler and Founder and Principal Consultant at Business Transition Solutions Dennis Leininger, shared their insights about options for succession planning and partner buy-ins. In this post, we’ll use their expertise to explain those options and how to best prepare for a successful succession.

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What is succession planning?

Succession planning isn’t the same as continuity planning, which involves setting up a designee to run the business in case of a sudden, catastrophic event such as death or disability.

A succession plan is a structured vision of how the business will change hands when the owner decides to sell it. The plan covers topics such as who the next owner will be (if they’ve been identified), what the current owner’s involvement (if any) will be after the sale, and how the sale will be financed.

Why is it important to plan ahead?

Many business sales involve a transition over a period of years, giving second generation owners time to get up to speed with the responsibilities of ownership before going it alone. Many owners will need a few years to get used to the idea of selling the business. They’ll want to know they did right by their clients and by their employees, and they’ll want a clear picture of their next life chapter. 

It's important not to rush the process. At Oak Street Funding, we encourage business owners to talk with us three to five years before their planned exit. That period allows everyone involved time to ask questions and research options. It helps avoid costly mistakes, such as having to accept a low offer to make a quick sale.

Different types of succession

The ways to organize succession are limited only by the creativity of the parties involved. This far-from-exhaustive list shows three options:

1. • Sell to multiple buyers over time
     In this case, a business owner has identified two or more individuals (often current team members) to take over the reins. One may take on client relationships while another assumes responsibility for operations. They purchase portions of the business in tranches over three to five years. This way, the new owners have time to get comfortable with their new roles before the original owner leaves.
   • Sell and stay 
     Some sellers don’t want to retire, but they want to give up the responsibilities and demands of ownership. They may want to continue working with clients as they phase out of the business.
     This model may be a good fit for intra-family succession plans. It allows a younger family member to take on the reins gradually while giving the original owner time to watch their legacy unfold. In these arrangements, it’s a good idea for the seller’s role to be well defined in the contractual documents so there’s no confusion about areas of responsibility and authority.
   • Sell and walk away
     Communication with clients and prospects is key. Consider hosting events and focus groups to identify clients’ interests and the best ways to communicate with them. Create new marketing tools using findings from the events.

Options in financing

Several different financing structures are available, and most can be used in a variety of succession models. Here are some common types:

All-cash deal

In an all-cash deal, the buyer finds their own financing and pays the seller a lump sum at closing. While the simplest, this arrangement is becoming less common in a merger and acquisition (M&A) deal, partly because lenders are less willing to make loans without some type of seller involvement.

Seller financing

Under these arrangements, the seller holds a note for part of the sales price and the buyer finances the rest through a lender. Many lenders look favorably on these deals because they keep the owner involved, increasing the likelihood that the business will remain profitable, and the loan can be repaid.

Earnouts

Earnouts are bonuses or portions of the sales price paid to the seller when the business hits certain targets at specified times after the sale. As with seller financing, lenders like earnouts because they provide everyone involved an incentive to keep the business successful, thereby generating the money needed to repay the loan.

Equity shares

Some sellers will accept equity shares in the business as partial payment. Sellers benefit from the firm’s continuing profitability without the responsibilities of day-to-day management.

How does a partner buy-in work?

A partner buy-in is similar to a succession sale, except that the owner is only selling off a portion of the business. At Oak Street, we often structure financing for partner buy-ins as multi-stage loans in which the new partner is the borrower and the business itself is the guarantor. The money to repay the partner’s loan will ultimately come from distributions (salary, etc.) the partner is getting from the company, so the company itself is the backstop for the loan.

Of course, we look carefully into the finances of the borrower and the company, but most of these loans do not require the borrower to use their house or personal assets as collateral. The future cash flow of the business is the collateral that supports the loan.

Making it happen

Two keys to a good succession plan are 1) starting early and 2) working with a team of advisors, including an attorney well versed in the seller’s industry, an M&A consultant, and a lender.

Most business owners will go through succession only once in a lifetime, so teaming up with experts who do it every day is a worthwhile investment. And the time to start is at least three to five years ahead.

Oak Street Funding has been making succession plans successful for over 20 years. Contact us today to see how we can do the same for you.

Ready to take the next step? Contact us or book a call today!