Doug Houser:
From Rea & Associates' studio, this is unsuitable, a management and financial services podcast for entrepreneurs, tenured business leaders, and others who are ready to look beyond the suit-and-tie culture for meaningful, measurable results. I'm Doug Houser. On this weekly podcast, thought leaders and business professionals break down complicated and mundane topics and give you the tips and insight you actually need to grow as a leader while helping your organization to grow and thrive. If you haven't already, hit the subscribe button so you don't miss future episodes. And, if you want access to even more information, show notes, and exclusive content, visit our website at www.reacpa.com/podcast and sign up for updates.
If there's one thing that never goes out of style, it's succession planning. That's because owners certainly want to ensure that the business they've dedicated their lives to is going to provide them with a desirable outcome, all while allowing them to retire worry-free. While planning for an ownership transition isn't necessarily the easiest task you'll undertake, it can be rewarding, particularly if you work with the right advisors.
Tim Jamison has been the right advisor for many business owners over the years. As a CPA and director at Prairie Capital Advisors, Tim has helped paved the way through many ownership transitions. In today's episode of unsuitable, he's going to give us a few tips that will help you get started on your own path.
Welcome to unsuitable, Tim.
Tim Jamison:
Yeah Doug, thanks for having me. It's a pleasure to be here and I'm excited about talking about this content that I basically live and breathe every day, so thanks for having me.
Doug:
Absolutely. Of course, in today's environment, it's so vital. We just have seen, particularly over the last couple of years, a real escalation at least in my small size of being out there in the market, just an escalation of closely held firms that are looking to transition in one form or another. Would you agree that that activity continues to be robust?
Tim:
Yeah. I think we're actually seeing unprecedented levels of owner transition over the last couple of months, expect to see that continue through 2021. 2020 was obviously a very weird year, with several months where there were no transactions going on at all because of the COVID-19 pandemic. And things really picked up toward the later part of the year, we had a very busy fourth quarter with a lot of year-end closings both on the ESOP and M&A side. It really translated into a really strong 2021. We expect it to be extremely active and very vibrant for the rest of the year and into next year as well.
Doug:
Yeah, that's good. I think it certainly like I said, feels that way to me when I'm out there in front of folks. You mentioned a couple of different types of transition there, in the beginning. Certainly, we've seen all of those, whether they be ESOP transactions, outside third-party M&A style transactions, inside deals to existing management or family members.
Walk us through, maybe from a high level, each of the nuances of those.
Tim:
Yeah. If you think about how you can transition the ownership of your company, we really break it into two brackets, an external sale, and an internal sale.
An external sale is really a third-party transaction where you're selling to another company or a private equity firm. So we have an M&A group that does both of those activities to sell your company outright. And there's a lot of advantages to that. You might have a really strategic party that could really help acquire you and take your company to the next level. And then, a private equity firm can really come in also and invest a lot of capital, and really take the company to the next level as well.
Those types of sales are really good for those business owners who are really looking to cash out as much of their money, if not all of their money, as possible at closing and then walk away, and really have limited to no involvement with the business ongoing from there. Some private equity firms will be passive and will require management to stay on board for some period of time, but a third-party sale to a strategic, you could most likely exit right away or after a very short period of time. And even with a PE sale, the length of time that you would be required or they would want you to stick around is probably limited in nature.
So you have those external sales, and then you have the internal sales which could be other people within your company, a management buyout. A leveraged buyout is another term for it, so you're selling your company to a key manager or key managers, to basically take over the company from there. It could be a family transfer, we do a lot of work with families that are a second, third, fourth generation, so you're basically just passing the shares, or willing the shares, or estating the shares down from generation to generation.
And then, the third internal sale that we do a ton of work in is in the ESOP world, employee stock ownership plans, where you're essentially selling all the shares of your ownership into a trust and the employees actually get the beneficial value of those shares over time. They don't actually own the shares, the shares in a trust, but the trust is a tax-exempt passive entity. It's really a way to build retirement wealth and really reward your employees for helping build the company that you had built over time.
All of those mechanisms can be put into play for those business owners who maybe aren't necessarily looking to exit right away, aren't necessarily looking to get the very top dollar for their company, or maybe not wanting every single cent of cash at closing either. An ESOPs a really good example of that, an ESOP has to be done at [inaudible 00:06:21]. A fair market value could be $20 million in an ESOP transaction, but a third-party, whether a strategic company or a private equity firm, might look at that company and say, "Look, if I do X, Y, and Z to this company, I can improve profits so I'm willing to pay $25 million for it."
Doug:
Right.
Tim:
An ESOP can't look at it that way. So an ESOP could be done at 20 million and most people will say, "Well, why in the world would you ever sell your company for 20 million when you could sell it for 25?" Well, a lot of business owners, 20 million sounds perfectly plenty. With an extra five million, and they know if they sell outright to a third party, that they're going to lose control, the culture, the legacy, all those things may change.
So for those business owners who are really motivated by keeping the culture intact or enhancing it, really maintain their legacy and rewarding the employees long-term, and are willing to stay around for a period of time after the sale, an ESOP is a beautiful mechanism for them to do that.
Doug:
Yeah, I wholeheartedly agree. We've been involved in quite a few of those over the last three or four years, and in general, they've worked very, very well. And again, from that perspective, the employees really buy into that culture, they feel like there's more empowerment. They see the rewards over time, as they see their statement grow year over year, as the company continues to do well. As you said, if that's important to you, some type of inside transaction works, whether it's an ESOP as you suggested or to an existing management team.
It's interesting to me because I've started to see ... I'm involved in a couple of third-party deals right now where they're in the midst of due diligence, looking at purchasing some clients of ours. I see these third-party folks, whether they're strategic or PE, trying to push back against that. And say, "Oh, we're going to come in and the culture won't change, and we're not going to do these things." I've found that to be generally pretty much not the case in the deals I've seen the last couple of years. I don't know what your experience has been on that front.
Tim:
That's exactly right. I'm actually working with a prospect now whose considering a third-party sale to a private equity firm, but he also wants to explore an ESOP. That's the whole reason, he's concerned about the culture and legacy of the company going forward. He understands that a private equity firm is making an investment in the company, they're going to do what they need to do to maximize that investment.
And look, there's nothing wrong with selling to a PE firm. It's absolutely the for a lot of business owners. It's why we as a firm really offer both M&A and ESOP services because it's really a case-by-case basis. But absolutely, if you're concerned about culture, legacy, the long term, the longevity if you will, of your employees, an ESOP is absolutely going to be a better play than a third-party sale.
Doug:
Yeah, it's interesting. Obviously, there's so much liquidity out there in the market, so these private equity firms and even strategic buyers, they've got to deploy this capital. They're very hungry for deals and obviously, they're going to be aggressive. But, in order to make the return on those deals work, they've got to be aggressive in squeezing as much cash flow out of that operation as they can.
Tim:
For sure.
Doug:
Certainly, different environments, different motivations.
You mentioned the current outlook obviously being quite strong through the remainder of this year, and it looks like certainly into next year. If I'm a typical closely held business owner, what are some of the things that I'm not thinking about? Maybe I'm very involved and I know the operations of my business, what about de-risking that business to make it more attractive? Are there things that they typically don't think about until the deal gets underway?
Tim:
Yeah, I think there are a few things you can do to really prep the company for sale. First and foremost is understanding the time constraints. So we deal with a lot of business owners in the third, fourth quarter of the year that goes, "Well, I really want to sell my company before the end of the year." Well honestly, you should have started several months ago because doing a third-party M&A transaction can take upwards of eight to 12 months if everything goes well. In an ESOP transaction, we typically say four to six months. It's quicker, it's more controllable, it's more friendly but still, it's a four to six-month process. So if someone wakes up one morning, October 5th, and says, "Okay, I want to sell my company by the end of the year," that's going to be really, really difficult to do. Timing is probably first and foremost, be thinking about it in advance.
But, get your financial records in order. You may have never had a CPA firm like Rea do a review or an audit, it's all internal. A third-party buyer, whether it's an ESOP, or an M&A, or a private equity firm, is going to want to see some financial statements that are prepared by someone else. So reach out to a local CPA firm and get some of those financial records put in order, it just makes the sale process that much easier. Same thing with legal records. If you don't have a really good board of directors minutes, or articles in a corporation, or all those things, get all that stuff put in place. So talk to a CPA firm, talk to your lawyer, talk to an advisor like Prairie and start prepping the company for sale months before you get into it. Because if you don't have all those things lined up, you can get into the transaction, the transaction will still get done but it's just going to add, it's going to add cost and it's going to add stress.
Basically, planning, planning, planning.
Doug:
Absolutely. I think that's certainly sage advice.
One of the other things I think that we see is we get started with the initial stages of a deal, if it's not somebody whose been involved in a transaction before, is thereof understanding of the level of due diligence that's going to take place, no matter which way that's done. Would you concur with that?
Tim:
Oh, absolutely. I think that speaks to the advisors that they have on board. So nothing against really small CPA firms or small law firms, but for the most part, those small CPA firms and law firms who might do really good work aren't really versed, if you will, in transactions. Don't be afraid to upgrade to a really strong CPA firm like Rea, don't be afraid to upgrade to a really good law firm that has lots of transactional experience.
If you're going to do an ESOP one of the first things we ask is, "Okay, who's your law firm?" It could be a really good law firm, but if they don't have an ESOP specialist in place, we need to recommend a handful of ESOP people in the law field to really represent them because it is such a nuanced transaction.
So really build a strong set of advisors, even before you start the transaction. Doug, you're exactly right, a lot of people just aren't transaction savvy, they don't have transaction experience and that's going to add, again, time, cost, and stress to the transaction.
Doug:
Yeah. We get involved in some of those where, as you said, maybe they haven't had prior assurance work done related to their financials, maybe it's just been a local CPA that's doing tax stuff or a small firm, as you suggest. They think providing the financial records for due diligence, whether it's third-party, inside the sale, whatever, is going to be similar to providing the information to that CPA that they do for their annual tax work. It's probably 5% of that, if that, as you're well aware.
And, rightly so. Think of it like they want to understand the value of that business. And you've got to understand okay, where are the risks in that business? Are there customer concentrations? All kinds of risks that are out there, that they're going to want to try to mitigate to the best that they can so that they're capturing that value.
Tim:
Absolutely. Yeah, I couldn't agree more.
Doug:
Now, speaking of some of those de-risking techniques. Will you assist a potential seller in terms of trying to mitigate some of those risks upfront, to help them through that process?
Tim:
Yeah, sure. We're full service, in that regard. We won't do the work ourselves, but we can look at financial records, we can look at legal records, make some recommendations to bring the right people on board. We can educate them about what a transaction looks like, especially on the ESOP front because ESOP is a very nuanced, and in a lot of people's minds, very complicated transaction. I'm still waiting for the day when I can talk to a prospect about an ESOP and they sign up, right at that first meeting. It just hasn't happened yet and I don't think it's ever going to, just because there's a ton of education and understanding of what an ESOP actually is. So we spend a lot of time upfront, educating, making sure it is the right transaction for them, showing them the cashflows, and bringing the right parties involved to help them with some of those matters.
The other thing that I would really think about if you're going to transition your ownership, is what's the next layer of management? That's also something, in your terminology de-risking, management succession is huge. Whether you're selling to a third-party or even to an ESOP, is that buyer, whether it's a financial or a strategic buyer, is going to look at, "Okay, Mr. Business Owner, you're running the company. Who are the next two people in line after you, and after them? And, what does your transition and succession really look like?" To the extent you don't have one, it's going to drive value down. To the extent you have a really strong one, it's going to drive value up. That's true in any type of ownership transition plan. That's a huge de-risking issue.
If you say, "I want to sell my company tomorrow, but I am the company. There's really no one to take my spot," you're going to have a hard time finding a buyer at a price that you're going to be happy with. So management succession is a huge part of that de-risking component that you were speaking of.
Doug:
Yeah, I concur. And we see that I think more and more, outside third-party users of financial information, regardless of whether there's an M&A transaction pending.
Tim:
Right.
Doug:
They're pushing that, too. I hear that more and more from the banks, financing providers of credit, surety providers, for example, in construction. That's a huge area of risk. If you think about it in today's world, you've got a large segment of the population of the Baby Boom generation reaching that retirement age or at least phase where they want to slow down and not be as devoted to that entrepreneurial creation, perhaps. It's really incumbent upon management to try to continually assess that and develop that.
We even see this with family deals, where maybe the next generation is working in the company but sometimes, they have no interest in actually running that business.
Tim:
Right. It's amazing how many second, third-generation companies we deal with that are ready to sell out because that next-generation either is in the business and doesn't want to be or just doesn't want any part of it. Or, we run into situations like, "Yeah, my son who's the fourth generation, he's in the business but he's not capable of running this."
Doug:
Yeah.
Tim:
"Let's structure a deal that protects him, I want him involved, but I can turn it over to him."
Doug:
Right.
Tim:
Yeah. Family dynamics come into play all the time for sure.
Doug:
It takes a lot to recognize that. I feel like sometimes we become pseudo counselors in that sense. It's okay to have these conversations, it's our job to try to get all those parties to the table and initiate some of that dialog, which can be challenging to actually say.
Tim:
Yeah. The counselor part of it, it's pretty key. I joke that a large part of my job is actually working with business owners to help them figure out the right transition. Convincing them to use us, quite honestly, versus my competitors. And then, once the transaction gets going, I become a therapist and counselor.
A lot of conversations during the transaction have nothing to do with the transaction whatsoever, in terms of the numbers.
Doug:
And it's emotional too, at the end of the day, because whatever structure takes place, all of a sudden they no longer own it or control it, perhaps, even though they might still be involved. That's emotional.
Tim:
There are so many business owners that I've worked with during my time in Prairie and even beforehand, where the business that they're selling is like a child. It's something they've done for so many years and in many cases, they started in a basement or a garage with one other person and they've built it to a multi-million dollar company. It's hard to let go. It's hard to let go of a huge part of your life. It does become very psychological and it's tough.
In the course of our firm's history, over 25 years, I've been with the firm over five years, I've had a couple of case just in my short time where the business owner wanted to walk right before we got to closing. He just dug in his feet and said, "I don't want to do this." And in one case his wife said, "Oh, you're absolutely going to sell the company. You're not walking away." It becomes a very hard thing to do. It's hard to let go.
Doug:
Well, it's funny you say that, too. It really becomes part of the identity. And frankly, in the most successful businesses, the owner really is part of that identity and brand.
In fact, it's funny. This dovetails quite nicely with Brad Circone, our wonderful producer here, who has his own podcast, I'll give him a plug, Getting The Brand Back Together. If you listen to some of the entrepreneurs that he talks to on his podcast, really those very successful ones, they are part of that identity, which makes it even hard for those types of folks, those successful folks, to let go.
Tim:
Absolutely.
Doug:
With that in mind, certainly, smooth ownership transitions are possible and we've seen those be successful. What, in your mind, Tim, are maybe the top two or three takeaways if I'm a business owner, that can help prep me to make that successful?
Tim:
Yeah. I think upfront planning, I think having a really concrete plan. "Hey, I want to exit in the next year," or two years, three years, six months, whatever that is, and really start backward from there. Really put together a strong team.
So Prairie's a registered investment bank that does valuation and financial advisory work. We don't do legal work, we don't do wealth management, we don't do accounting work. We can help bring those parties together. But, you really need a whole cohesive team and family to help with that transition. Legal, accounting, wealth management, things of that nature, so putting that team together.
Then, really setting realistic expectations of what you want and what you need. So that's one of the first things we always ask people. What is it that you want for your company and what do you really need to live on for the rest of your life? Is it feasible, does it make sense? And then, move from there. All that really is around planning, and just putting the team together and have a really solid set of expectations. Because there's nothing worse than talking to a business owner that says, "I think my company's worth $50 million and I'm not taking a penny less," and you get into it and it's worth 25. I can't get you to 50, I just can't. So just having a really solid set of expectations.
Doug:
Yeah, I think that's so well said. Oftentimes, we hear that, too. Obviously out in the community, you'll hear noise, "Oh, I was talking to so-and-so, my friend at the club," or this or that, "and they said they got eight times for their company." It's just like well, did they really? You know how that goes.
Tim:
Exactly.
Doug:
You can start somewhere, but let's talk about realistic expectations. And again, to your point, you've got to have all those parties together. To treat any of this as if it's in a silo, I think you might do yourself a disservice for sure.
Tim:
Yeah. I got asked by someone today about tax advice and I was like, "We need to call your accountant." I'm actually a CPA, I still have my certificate, but I'm not going to give someone tax advice two or three times out of the year when there are people that do it for a living, all day long. Let's bring the right parties in and get the right answer.
Doug:
I wholeheartedly agree with you. Let everybody be the expert in where they truly are an expert, you'll get the maximum value that way.
Tim:
Absolutely.
Doug:
We say the same thing. When we get approached, well yeah we can assist. There are parts, the tax advice, the planning, things like that. But, we're not investment bankers either, and that's where we want to talk to somebody like you. Hey, you're out in the market doing this every day.
Tim:
Right. Let the people be experts at what they're experts in and it'll definitely pay off for the business owner for sure.
Doug:
Absolutely. Well, it's sage advice, Tim. I really appreciate you being on today, and certainly look forward to having you on again in the future as we continue to monitor trends in the M&A world, as it relates to owner-managed businesses.
Tim:
Absolutely.
Doug:
Thanks again.
Tim:
Thank you so much for the time today, I really appreciate it.
Doug:
Absolutely. And if you want more business tips and insight, or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast. And while you're there, sign up for exclusive content and show notes.
Thanks for listening to this week's show. Be sure to subscribe to unsuitable on Apple Podcast, Google Podcasts, or wherever you're listening to us right now, including YouTube. I'm Doug Houser. Join us next week for another unsuitable interview with an industry professional.
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