What kind of exit do you want?
Continuing on from exploring the two main goals of succession planning, Jeremy Kitchin takes us through all the options on the table when it comes to making an exit.
The succession options
Nothing is more sensitive than placing a value on an accounting practice. In general, buyers from outside tend to pay more than internal purchasers. Insiders believe that they have helped build the firm over the years and are hence paying for business they brought in or developed. Unless the buy-out is clearly articulated in the succession plan, or other agreement, you can be heading for serious trouble.
You should review the buy-out formula every few years to make sure that it still makes sense particularly with regard to the current economic climate and size and structure of the firm.
Make sure that you have clarity around these points:
- How is the value of the firm calculated?
- What happens in the case of owner disability or death?
- Over what period of time will the owner divest himself of his equity?
- Is there a maximum amount that can be paid out to retired owners each year?
- What happens if the firm cannot meet its commitments in any given year?
The selling options
As an owner looking to build value into your practice, perhaps with an eye to a future sale, you should look at your structure, as there is also the alternative of incorporating only some aspects of the business, in particular corporate finance, financial services or bureau services (bookkeeping, payroll, outsourcing, etc) these can then be sold off separately.
Do you sell to insiders via a management buy-out or an outsider?
The management buyout
Although the concept of a management buyout has been common practice in commercial concerns for many years, it has only fairly recently emerged as a strategy for accountancy practices. Many practitioners have helped their clients with MBOs, but it may never have occurred to them that this could be a way out of their own difficulties. Perhaps because firms are starting to adopt a much more commercial attitude towards the operation of their practices, or because of the increasing popularity of alternative structures such as LLP’s, firms are broadening their outlook when it comes to planning for the future and are starting to think like their clients. Rather than go through the sometimes tortuous process of a sale or merger, some firms are now looking closer to home for solutions. Associate or salaried partners or senior managers, who currently have no financial stake in the business, may well be ambitious and would be delighted to invest in their own and the firm's future, if only they were asked.
Practice owners often feel that the more junior members of the team are not up to the task of running the business (the small businessman’s syndrome!). Indeed, their technical abilities may not be good enough, or they may lack the necessary leadership skills, but most of these things can be learned if the enthusiasm is there and there is a plan to follow.
The beauty of an MBO is that it can be phased over a number of years, thus allowing the up-and-coming owners enough time to grow into their roles allowing the retiring partner(s) to make a planned exit.
Another great advantage to an MBO is that there is no significant upheaval within the practice to alarm the clients. Instead, they continue to receive the same service from the same familiar faces, and when the existing owners do retire the new owners will have been well prepared.
MBO’s are bringing a new style of business ownership that is set to become more popular as the benefits are better understood. But it is vital to recognise the need for new working capital to replace what will be taken out and be sure that it will be available when it is required.
Don't think of the transition as just affecting staff. Partners too will be going through much of the same emotional and psychological trauma. If you do anything during the post-merger period, make sure you talk with each person, new and old, in the firm. Everyone will be concerned about what the merger means to them. If you are reducing staff, do it before the merger happens. Take as much of the unknown away so that everyone is dealing with facts not fiction.
Set up transition teams to cover the major areas – benefits, salary structure, systems, scheduling, etc. The better your internal communications, the smoother the post-merger phase will go.
The merging option
A merger will never solve an existing problem in your firm. It is not a solution to partner problems. Make sure you have your own house in order before inviting someone in. There are significant benefits for you and your firm if you plan for a successful succession:
- You will enhance the value of the practice
- You can retain your most talented people and potential successors
- You should never be caught in a "fire sale"
With SMEs, many mergers are driven by the desire of some of the owners to release capital, reduce their level of commitment or as a pre-curser to retirement. These are not always the best motives for those lower down the pecking order, but being aware of the possibility ought to prompt discussions about planning for succession.
Mergers take place for a variety of reasons, i.e. to increase the overall profits by achieving an economy of scale; to create a bigger critical mass, thus enabling a more structured workforce to be put in place; to dilute the amount of practice administration per partner or, in some cases, to transfer the practice administration from one partner; to enable the partners to 'play to their strengths'. It often provides a logical solution to the problems of succession. But, be aware; almost all mergers end up as takeovers once the dust has settled. Very few deliver the benefits they promise. They are fundamentally difficult and dangerous. Hard-nosed pre-planning is absolutely essential, preferably involving an experienced outsider to ask those difficult "what if" questions.
Merging your firm can appear to provide a logical solution to the problem of succession. As an owner, you should also think very carefully about what makes merging two practices work. Many mergers are driven by the desire of the principals to release capital, reduce their level of commitment or plan for retirement. This can impact on productivity. There are no easy answers, but being aware of the possibility ought to prompt some planning about succession.
With succession still a major cause of concern for firms in the independent sector, a new idea for raising the necessary capital to fund partners' exit routes can only be a good thing.
The consolidation option
As part of your exit plan, talking to a consolidator in advance of retirement is an alternative to selling or merging. Currently there are two listed on AIM: Vantis and Tenon. However, a number of practices are growing rapidly across the country by ‘consolidating’ without listing on the investment market. They are inviting independent practices to join them and come under their umbrella. These include firms such as DTE, Haines Watts, Bentley Jennison, UHY Hacker Young and Target.
Joining a consolidator offers many advantages. First, you would have access to the necessary funds to enable you to upgrade your systems, particularly your IT system. Your administrative processes would normally be centralised and your clients would have access to value added services not normally available to the smaller practice. With some consolidators you and your partners would be able to crystallise your goodwill, being immediately bought out with a mixture of cash and shares and, unless any of you wish to retire, you would be invited to join the management team and earn an income stream. Much greater career opportunities would be available to your staff, right across the group. Joining a consolidator would take care of any succession problems.
Transferring the business on death
Following the death of the business owner, one of the more important aspects of business succession planning is working out the financial pitfalls; answering questions like: Where will the money come from to pay taxes? Or, if the business is a partnership: Where will the money come from to buy out the deceased partner's share?
Because clients commonly take their business elsewhere following the death of an owner or reporting partner, how do you make sure adequate capital will be available to carry the business through what could be a slow transitional period?
Many of these questions can be answered through the proper use of such funding vehicles as life insurance, annuities, and disability insurance, and often at little or no net cost to the business. But the time to work these things out is before the situation arises, not afterwards.
Don't think business succession planning ends with an estate plan and life insurance firmly in place. Business succession planning must also include a plan for transferring the trust, respect and goodwill that's been built up over the years. If the recently departed owner was a large part of the reason clients were willing to do business with the firm, these clients need to be reassured that they will continue to receive that same quality of attention and service. One of the best ways to accomplish this goal is to start transferring such loyalty while the owner is still around. That can be done by introducing clients to younger associates now, and by shifting some of the responsibilities connected with such accounts to those associates. Get the clients comfortable doing business with the "next generation" of ownership, with no change in service. Better yet, let clients see an improvement. Teach younger associates that they should keep in touch letting clients know that they are important and that you value their business. Little-by-little, the "owners to be" will earn clients' trust and confidence.
Another aspect of successful business continuation is earning the trust and confidence of not only the business's clients, but its employees. This means paying attention to the details to retain good employees. Is the work environment pleasant? Do people have the support and technology they need? Do they feel appreciated and a part of things?
Read part one of Jeremy Kitchin’s series: “Succession planning: Plan your exit”.
With his daughter Lucinda, Jeremy Kitchin runs Jeremy Kitchin Practice M&A, a specialst broker that trades as APMA.