internal succession deals Archives

Today’s guest, Michael Vann, is a highly motivated and driven Business & Transaction Advisor at the Vann Group. Michael has over 18 years of experience in both corporate and entrepreneurial settings. He has a passion for the growth and development of high impact companies. He’s also shown a proven ability to advise clients in a manner that results in growth and success. Using his knowledge and expertise, he is able to work with clients to develop strategies and solutions that build on a company’s existing foundation, unlocking its unrealized value. Ultimately, Michael also works with clients on succession deals, including internal succession.

Early Deal Making

Having grown up in an entrepreneurial family, Michael notes he always had a bug for business. Although M&A wasn’t on his radar early on, creating businesses and doing deals certainly was! The first big deal Michael was part of involved selling a coffee shop, which went quite well.

Now, Michael’s activities focus on serving as a trusted advisor to owners and leadership teams that require insight and execution of strategic initiatives and transactions. This includes areas like mergers & acquisitions; the development of joint ventures & strategic alliances; the acquisition of financing and capital; and the launch of new business models & divisions. As an industry agnostic, Michael has successfully worked in a wide range of industries, including insurance/financial services, industrial/business services, manufacturing, and food & hospitality.

Internal Succession Deals

Michael and his father, Kevin Vann, recently co-authored Buying Out the Boss: The Successor’s Guide to Succession Planning. (And back on Ep. 88, I did a solocast on internal succession deals and opportunities!) So I knew my discussion with Michael about internal succession deals would be a great follow-up.

First off, Michael notes that there are many moving pieces in a succession deal. Those moving parts are what attracts Michael to internal succession, as he finds them challenging and enjoyable to work on.

Small, local companies play a large role in the economy, as well as in their own communities. Internal succession deals are a way to keep them locally owned and operating, even when the original founder steps down or moves on. Another key component to succession? Maintaining company continuity and growth through a succession.

Michael notes a stat that over 50% of business owners don’t believe their successor was prepared. He works with business owners to help them build the support and systems needed for a healthy succession.

The Buyers Don’t Always Know What They’re Getting In To

At the start of the succession deal, Michael notes that buyers are often at quite a disadvantage. They don’t always know the ins and outs of everything they are getting into, and they are sometimes coming from the position of being an employee. Even if they know the business, that knowledge is usually constrained to a specific area.

Transitioning to being the full fledged owner and CEO of a business is a huge shift. It’s not just about taking on a new title. This may help us understand why only 6% of successions involve an existing employee.

Michael notes that not every employee has a desire to take over a business and become the CEO either. Just because an internal succession deal may seem desirable, he cautions business owners to remain aware that they may not have an employee who would truly make sense to take over.

If you know you’ll one day desire to transition out of your business, you need to know it can run without you! It’s tempting to remain heavily involved, but you can make yourself more attractive to both internal and external buyers if you can demonstrate that the business can remain stable without your constant oversight and presence.

Conversations with Owners

Michael notes that there is a difference between scale and value. Many people can find a way to scale, but not everyone can build long term value that lasts.

From the perspective of a potential buyer, long term value is much more important than the ability to scale. Business owners need to move beyond short term thinking and consider what parts of their business are saleable, or worthy of passing on to the next generation.

Unfortunately, family businesses tend to have low statistical success rates across the generations. Michael has seen that keeping the second generation vibrant and growing is key to their success. Beyond that, however, he tends to see a downward spiral in experience moving into the 3rd and 4th generations of family businesses. Sometimes later generations are coming into the business from a place of entitlement, and other times they are there out of obligation. Either way, it doesn’t tend to translate to success.

I noted a practical problem that also occurs is that most generations get successively larger. The math gets quite hard when ownership is splintered among 15+ people, as getting people on the same page can be quite hard and the business needs to support more people.

Family strife, differences in vision and direction, and willingness to take risks all come into play for multi-generational businesses.

Trends in the M&A Market

When Covid hit, Michael’s group saw three deals stop dead in their tracks. Eventually one moved forward, but the other two died. Around May, however, they saw things start moving again.

He attributes this to business owners who are accelerating their transition processes after having watched the way the market has been moving. Increased uncertainty has caused a number of owners to decide to get out now while they can, even if their numbers are a little lower than expected.

Michael did note that they haven’t seen any large valuation impacts yet. He’s encouraged clients not to panic, and has seen plenty of active buyers in addition to sellers. By making wise decisions from a calm place, most business owners should have the ability to make solid decisions regarding their futures despite challenging times.

For deals that are moving forward, there has been an uptick in clawback provisions. This creates a balance for both sides of the transaction, and may be worth considering if you enter a deal in the near future. As a structure, it protects both sides and creates a bit more deal security. I agreed, noting that our firm has seen a similar trend.

In Massachusetts where Michael is located, he notes they’re in a strong manufacturing market, with precision aerospace and medical devices especially. There is a great asset base there, and the deals tend to be quite solid.

Whether you’re looking to buy or sell, the market is solid and deals are getting done every day!

Listen in to Episode 94 to hear the full interview and get Michael’s take on some of the biggest mistakes people make while trying to get deals done.

Corey Kupfer is an expert strategist, negotiator and dealmaker. He has more than 35 years of professional deal-making and negotiating experience. Corey is a successful entrepreneur, attorney, consultant, author and professional speaker who is passionate about deal-driven growth. He is also the creator and host of the DealQuest Podcast

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If you want to find out how deal-ready you are, take the Deal-Ready Assessment today!

What is the likely time you’ll want to retire? What happens if circumstances force you to leave your business earlier than planned? Your retirement and ownership transfer may be on your own timing, or dictated by things you may not control. Either way, having as many options as possible is advisable. While you might be able to sell to an outside party, you should also consider having internal succession on the menu.

How to Best Position for an Internal Succession Deal

Depending upon the size of your company, grooming a successor and/or building a strong executive management team is crucial. Empowered, knowledgeable employees create a potential pool of buyers. These buyers might be excellent candidates for a buyout when you’re ready to retire or move on. The great thing about doing that is your company is more likely to be able to operate without you. As a result, even while you have full ownership you’re putting yourself in a strong position for an external sale as well.

An internal succession deal is essentially an opportunity for you to sell your company to your existing team or one key employee. This may occur upon your retirement, death, or permanent disability. Creating an internal succession plan and binding agreement in advance with the management team or key employee is an essential step toward a successful internal succession deal.

Advantages of Internal Succession Deals

One huge advantage of this kind of deal is that you’re working with someone who knows the company. They understand the company culture. They’re also familiar with the ideal clients and the “state of the union”, so to speak. They may not need to spend as much time doing their due diligence and understanding the company at its core. (Note: They also know your skeletons, so there is a lot of transparency in most internal succession deals!)

If you’ve built a great company with a great team, an internal deal can require less “selling” of the deal. Another advantage? Continuity! Relationships in business matter. Clients and customers are often more comfortable when they understand they’ll be able to continue working with the same team and philosophy. They are less likely to completely revisit the relationship when they feel they are still working with the same people.

Also, a majority of deals are done as asset sales. (As opposed to equity deals.) After all, the buyer doesn’t want to take on a huge liability risk. This is often the structure for an internal succession deal as well. However, there are possibly more opportunities to consider an equity deal when you’re dealing with someone who truly knows the ins and outs of the company. They are taking on less unseen risk. This may make an internal buyer more open to the potential heightened risk of an equity sale. This is a huge plus because equity sales can actually be smoother than asset sales.

(Listen to the full episode to hear more about assignment issues, consents, and a note on taxes!)

Finally, consider making it known to key employees that you’re willing to consider an internal succession deal when you reach retirement. You may be able to retain high-level employees who have a desire for ownership. When these employees know that they will have the option to gain majority control, or maybe even 100% ownership in the future, that may be the incentive for them to stay. Even if a larger company offers them more benefits or higher pay, ownership incentives (which can be set up in advance via legal agreements) will often outweigh other benefits and perks offered by larger companies.

Disadvantages of Internal Succession Deals

A possible downside to internal succession is lack of funds. There may not be an ability to pay the purchase price if the internal buyer can’t find the necessary capital. There can be limited funding options, and internal buyers sometimes want the owner to essentially fund the note and get paid over time. Although financial options are increasing in many industries, the lack of capital is sometimes an impediment to internal succession deals. One antidote is to plan in advance. Pre-planning increases the chances that an employee interested in buying the business out will have the ability to finance the deal.

When deals are done internally, there is often a lower valuation. This corresponds with a price discount — even if small. This can be because the deal is easier to get done. It may also be a result of working with people you trust, recognizing their contribution to the growth in value of the company over time, or other reasons. External buyers are often able and willing to pay a bit more for their own strategic reasons. However, they bring other issues and risks that may not exist for an internal sale.

Setting Up the Deal

There are a number of ways this may be done. For example, you may set this deal up where an internal buyer is able to buy the company over time. This could be at 5% a year, or some other breakdown that makes sense. You may also consider how much a buyer would need up front, how much they can pay over time, and whether this is a full buyout or if you’ll retain minority stock or equity in the company.

When you’re allowing employees to buy into a company over time, the owner often does not want to put themselves into a position in which they are still working in the company but now have a minority ownership. This can be remedied by creating legal agreements to ensure that you have control of decision making within the company until the point at which the buyout is going to be completely transitioned. For example, a structure at which the full out buyout occurs after ownership by the buyer reached 49% over time. So while the buyer might have been buying 5% – 10% a year over a period of year, for example, after reaching 49%, the next purchase is for the remaining 51%

Also, remember that you can divide ownership and voting control. So you can give up the majority of the economic benefit of equity ownership while still maintaining decision-making control.

Another consideration: what assets will be used as security for backend payments? In essence, if the buyers don’t pay you, will you be in position to take the company back? What recourse will you have? In reality, most people don’t want to be in a position in which they would be at risk of having to leave retirement in order to reenter the company. For that reason, you may consider other forms of security or protection.

Best of Both Worlds

There can be some frustration here. An employee making the purchase may be trying to have the best of both worlds by taking on ownership of a company without the risks of buying something unknown or starting something new. They may not want to offer a second mortgage on their home or other personal assets as collateral against possible failure. Or they may not have those things as an option.

Although internal succession deals can be wonderful for both parties, it is essential that there are protections in place to protect against worst case scenarios. Be clear about what you’re comfortable with when you show up to the deal table.

In an internal deal, you know who you’re dealing with.

You know if you’re passing the business into capable hands, and ideally you’ll know enough about their work ethic and way of thinking to know that they’ll carry the business forward. However, you don’t know what could happen with all sorts of factors: the economy, global pandemics, unexpected losses, and any number of potentialities could arise that complicate an otherwise solid business deal.

Finally, I would encourage you to truly spend some time pre-planning your own transfer and retirement. Do you have the right people in place? How will you preserve your legacy? Do you want a slow transition or a full stop when you’re ready to be done? Are you dealing with yourself as a single owner, or do you have business partners/founders whose views are important?

Listen in to the full episode for more strategic thinking on internal succession deals.

Corey Kupfer is an expert strategist, negotiator and dealmaker. He has more than 35 years of professional deal-making and negotiating experience. Corey is a successful entrepreneur, attorney, consultant, author and professional speaker who is passionate about deal-driven growth. He is also the creator and host of the DealQuest Podcast.
If you want to find out how deal-ready you are, take the Deal- Ready Assessment today!