Succession planning? Look to key employees for possible buyers

—Sponsored article by Blue Chip Leasing

At some point, the owners of most manufacturing companies will eventually take a moment to start thinking about how long they want to continue to work, and if they don’t, they wonder how they can get out. Many of the businesses I work with are owner-operated. These owners typically decided at some point that they were tired of working for someone else and ultimately, went out on their own.

In many of these cases, family (who may have been brought into the business at an early age) have aspirations of eventually taking over the business. However, I see just as many situations in which nobody from the next generation has either the interest or experience to run a manufacturing shop.

Often, it’s key employees who clearly have the skill set. The irony is these are normally the individuals who often end up leaving at some point to start their own shop, so who better to be part of a long-term solution for divesting the business?

Obviously, a number of factors need to be in place to have a meaningful discussion about a long-term transition, but it’s never too early to have a conversation.

One of the scenarios I see a lot is a shop owner who is older, clearly has had enough, and the disinterest is starting to show on the financial statements as declining sales and profitability. They realize they need to sell the business sooner rather than later, and jump at the first opportunity as opposed to taking the time to find the right purchaser who will pay the highest price.

Establishing a valuation isn’t an easy exercise. There are people who specialize in business valuations and can produce a report just like one an equipment appraiser can prepare for a machine. I have customers who have purchased existing businesses outright for cash. However, in cases in which the company is well-established, profitable, and has a significant amount of assets, such as your typical manufacturing shop full of CNC machine tools, it may be tough to finance this transaction with cash.

It’s also very important for any new owner to ensure they have ample working capital to run the business, so tying it up in the purchase doesn’t make much sense either. This means a lender is often needed to help finance the transaction. If the business is being sold to an employee, continuity is established right from the start, and the transaction doesn’t have to be funded 100 per cent by using a vendor take back (VTB).

A VTB usually involves the buyer paying the current owner a percentage of the sale price over time with interest. The actual percentage differs depending on the situation, but most importantly, it gives the financial institution doing the lending a level of comfort because it’s not financing the entire transaction. An ancillary benefit of the VTB is it keeps the seller engaged because it’s in their best interest to ensure success for the new owner so they have the wherewithal to ultimately pay what is owed. Many times the seller remains on as a consultant.

Beyond securing financing, the VTB gives the buyer some recourse in the event of a surprise cost that either wasn’t disclosed or could not be foreseen before the transaction and could potentially be a device for recovering some or all of this cost. There are a number of ways to facilitate this type of transaction, particularly if there is time left for creativity.

Having come from what was a well-established and successful family business that ultimately ended up closing, I can tell you firsthand that it is never too early to start thinking about the future and a plan for succession. It could very well be the case that the buyer who not only makes the most sense but is also in a position to pay the highest price is already working on your shop floor.

Ken Hurwitz is senior account manager with Blue Chip Leasing Corporation, an equipment finance company in Toronto. Ken has years of experience in the machine tool industry and now works to help all types of manufacturers either source or tap into their own capital to optimize their operations. Contact Ken at (416) 614-5878 or at via email. Learn more at www.bluechipleasing.com

This column originally appeared in the July 2017 edition of Canadian Metalworking.

The article is part of the Financial Management Success Centre, showcasing strategies to access working capital, reduce costs, and leverage the value of shop floor equipment.