It’s an open secret that many business owners, regardless of their organization, routinely overlook an important task: developing their exit strategy.
The right transition plan depends on the nature of the business and the business owner’s goals, both professional and personal, such as cash flow requirements in retirement. Here are some common examples of succession planning:
- Transition to the next generation for the family business
- Sale to employees, including via an employee shareholding plan (ESOP)
- Resell the property interests to the business or a co-owner
- Sell to a third party
Either way, COVID-19 has complicated a process that remains essential for the survival of the business and the preservation of the wealth it has built for its owners. Valuation is one of the main complicating factors. The pandemic has added a host of new considerations when evaluating a private business.
The most common methodology used to value private companies, especially in sales to third parties, is the market approach, which relies on historical profitability, typically EBITDA, to value a company. This creates a problem when the pandemic has altered EBITDA. Owners should determine whether the effects are temporary or permanent by analyzing the effect of COVID-19 on a company’s EBITDA and determining how those effects should apply to its valuation.
Existing shareholder agreements and other agreements governing succession planning often value a company at the end of a logical period, such as the end of the last fiscal year. This timeline may be inappropriate given the significant disruption caused by COVID-19; current valuations will need to be considered more carefully and creatively analyzed to arrive at a fair valuation for all parties.
The pandemic created many other complicated considerations, such as PPP loans / remittances, new employer obligations to employees, and the enforceability of “force majeure” clauses based on past closings or potential future closings. Each circumstance could impact assessment and transition planning.
These factors – and others associated with our uncertain economic climate – will be part of the due diligence process and will be negotiated in the company’s transition contracts. The added uncertainty can give both buyers and sellers a short-term break.
While COVID-19 presents many challenges for business owners in transition, there are potential benefits, which could make the decision to suspend a transition a costly misstep. An owner may want to specifically continue with the transition during the pandemic for several reasons:
- Lower trade valuations can mean a lower tax bill if the donation is part of a transition strategy. Currently, an individual can donate a business worth up to $ 11.7 million without federal tax; this amount will be halved in just five years under the current law. Speeding up a planned transition to take advantage of both lower pandemic-related valuations and current federal tax laws might be just the window of opportunity needed to move operations.
- Falling interest rates during the pandemic made more credit available to more potential buyers, possibly increasing the interest of buyers. According to the company, some buyers may have relatively few reservations in the current climate because they can see the post-pandemic potential of the business and get a good deal on interest rates.
Whether or not it is a pandemic, business succession is a long-term process filled with challenges, even unexpected opportunities, but careful planning and periodic review is essential because life is full of surprises.