Protecting the value of a professional service practice
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For professional service providers such as CPAs, registered investment advisors, and independent insurance agents, their businesses don’t just provide ongoing income; it’s also a source of value that can fund other business ventures or retirement. The business only retains value, however, if it is sellable. That’s why it’s important to operate a business from the start with an eye to selling it, even if the sell date is well into the future. While succession planning might appear to be a concern for the distant future, initiating it early is vital for retaining a business’s value as well as improving ongoing profitability.
Thinking about the future
When most professional service providers start their careers, retirement is hardly on the radar. Building up a client base and increasing revenue take precedence. Once providers move into an ownership role, however, succession planning should be an integral part of doing business.
Owners should be asking themselves, “What do I want to do when I want to stop being in this business? Do I want to close the door and walk away, or do I want to sell the business and use the value I’ve built up in it over the years to fund my retirement, or perhaps another business?” If an owner plans to sell, it’s vital to operate the business with that goal in mind from day one.
The reality of selling a business
It may seem like all a business owner needs to do is put a For Sale sign on their business and negotiate a sale price. The reality is far different. According to research from the Exit Planning Institute, 70 to 80% of small businesses do not sell.
There are several reasons why a business may not sell, even if it has been profitable under its original ownership:
- Not in growth mode – Buyers are looking for practices that are growing. An owner who takes their foot off the gas to coast into retirement risks lowering the company’s value and losing the interest of potential buyers.
- Difficult company culture – No one wants to take on someone else’s problems. If there are personnel issues that haven’t been dealt with, astute buyers will sense that and be put off by them.
- Too much reliance on the owner – It may be a source of pride to be the owner who can do everything, but if institutional knowledge isn’t shared throughout the company, it can sink potential deals. Buyers are looking for a seamless transition; the business needs to be able to operate effectively without the original owner being present or have a solid transition plan.
- Unclear financials – Believe it or not, the absence of clean financials scuppers a lot of acquisition deals. Buyers will expect complete and orderly financial records for at least the last three years of business. Keeping the financials in good shape is a best practice, and it will pay off when the time to sell arrives.
Preparing for different types of sales
Succession planning will look a bit different depending on the type of sale that is expected. Internal succession, where the new owner comes from within the ranks of the existing team, involves identifying a willing and capable candidate at least three to five years before the owner’s planned exit date. There should be a structured and documented system for mentoring that individual in the responsibilities of ownership so they can take the reins confidently when they move into the owner’s position.
If there are multiple owner-partners and one wants to leave, it’s vital that there be a buyout clause in the partnership agreement. This clause will outline the acceptable triggering events for a buyout, how valuation will be determined, and other terms of the buyout.
For external sales, the key focus is on presenting a business opportunity that is growing, has reliable cash flows, and is not dependent on any single person for its success. Clean financials and evidence of a healthy company culture will support that presentation.
Moving forward
Succession planning is a team sport. A business owner should discuss their exit strategy with their accountant, their attorney, and a trusted lending partner who is familiar with their industry. They may also want to involve a merger and acquisitions consultant. It’s never too early to have these conversations. The end goal of the business should inform how it is run every day.
Keeping a company sale-ready is good business practice, even if it will be years before the company goes on the market. Operating with eventual succession in mind can grow a business’s value and help secure its owner’s financial future.
Alicia Chandler is president of Indianapolis-based Oak Street Funding, a First Financial Bank company, with customized loan products and services for specialty lines of business including certified public accountants, registered investment advisors and insurance agents nationwide.