April 3, 2020

The Business Succession Matrix

by Tim Jochim, Partner, Walter | Haverfield LLP

Business succession is a complex interplay of perceived feasible alternatives and the perceived costs and benefits of each alternative. After hundreds of transactions and even more presentations to company owners, one of the most effective decision making tools seems to be an interactive business succession matrix, both as an information device and to facilitate informed self-selection by business owners.

The Matrix is variable and flexible in terms of transaction alternatives including, but not limited to, third party sales (stock or asset and financial or strategic), internal buyouts (management or cross purchase), employee stock ownership plans (ESOPs) and transfers by trusts (family or charitable).

In turn, each transaction alternative is assessed by the perceived benefits and costs by the user on a “Scorecard” spreadsheet, subject to certain market parameters. By way of example, a company owner may seek a strategic buyer because of the perceived high level of price and liquidity and a relatively low need to manage the business or maintain the company culture after the transaction. In this instance, perceived costs would include loss of control and company culture as well as transaction costs associated with retaining qualified sell-side advisors. The company owner has the ability to weight each benefit and cost within the parameters of known market data. For example, given known market information, it would not be realistic to expect a profitable mid-market commodity widget company to be sold with no tax consequences at 10 times EBITDA and with less than one percent in total transaction costs.

Again, subject to known market parameters, the company owner can weigh the relative importance of each perceived cost and benefit resulting in numerical scores. Most of the perceived costs, as noted above, are known, but, as to ESOP transactions, a regulatory risk factor has been introduced.

Over the past 10 years, the U.S. Department of Labor has initiated numerous complaints against ESOP trustees and selling company owners alleging overstated and defective valuations and unfair insider benefits at the expense of the ESOP and its participants. Nearly all of these complaints involved leveraged ESOP transactions structured by investment banking firms—which have no liability for the transactions. The Matrix provides guidance on minimizing this regulator risk and on solving the business succession enigma.