Why you should train your successor before you need one

Through creative financing and help from an advisor, Deepak Singh was able to successfully transition his manufacturing business to his top manager.

People and events featured in the Green Lake series are composites based on real MNP clients.

Deepak Singh knows a thing or two about family, friends and transitioning from a business. Although he retired to his Green Lake cottage from the family manufacturing business two years ago, he had run the business for half of its 35 years, taking over from his father.

Deepak expanded the business significantly under his father's watch. By the time he was in his mid-forties, annual revenues had tripled to $15 million and were growing. Success was sweet, but brought concerns.

"I was worried my business was starting to be worth too much," he said, while enjoying a community barbecue out at Green Lake. He wondered if he could find someone to pay a fair price for the business by the time he wanted to exit.

Working with his MNP advisor Candace and her team, Deepak began to explore his options. While not in a rush to sell, he did want to start narrowing down potential buyers to ensure he could leave on his own schedule.

To establish some touchpoints, Candace asked Deepak a series of questions. How could they make the business more attractive to a potential buyer? Was there anyone within the business who could step up and assume more responsibility, perhaps even become a partner or an eventual buyer?

Deepak immediately thought of his most reliable manager, Roch. But he was concerned that Roch lacked the necessary funds to buy the business. Candace advised offering Roch a partnership: If he accepted, Deepak would lock up a key employee for the long-term and be he'd able to hand over more responsibility over the next few years, ensuring business continuity.

Roch was very interested, but acknowledged he didn't have much capital to put in the business. After more discussion with their MNP advisor,  Roch agreed he would use equity in his house to make a $350,000 investment in return for 10 per cent of the company.

The partnership worked well. Roch assumed more of the day-to-day management from Deepak and introduced a number of improvements to internal processes that saved the company money. After a few years, Deepak began to think more seriously about getting out, and met again with Candace to discuss selling the business to Roch, knowing he didn't have enough capital to buy the business outright. Roch understood the business, he had the loyalty and respect of staff and he had the greatest chance of succeeding with it.  When Deepak told Roch he was thinking about selling, Roch immediate said he'd be interested in buying.

Candace reached out to her partners in MNP Corporate Finance. They proposed a form of cash-flow financing, an institutional loan that didn't require as much collateral. Because the business was consistently profitable, the bank would rely on the positive cash-flow to finance a large portion of the transaction.

Deepak and Roch agreed on a value of $5 million for the business. Roch already owned 10 per cent, so he would have to come up with $4.5 million to make the deal work. The bank agreed to lend Roch $3.25 million to put toward the transaction and Deepak agreed to finance $1.25 million of the transaction in a vendor take-back. He also agreed to make his loan secondary to the bank's, meaning he would get paid only after the bank did and he would be behind them in line to get his money if the deal fell apart.

Before everything was signed, Deepak hosted his entire family at his cottage to discuss the transition. "Everyone in my family had an opinion on what I should do with my business," he said of the ensuing discussion. But Deepak remained confident Roch would run the business well and that his loan would be secure.

He was right. Within two years, Roch had increased annual revenues by $5 million. He found more efficiencies to increase profitability, made all the regular payments to the bank and still had money left over to pay down his debt quicker.

Deepak was thrilled. He had always assumed that a larger company or a competitor would buy his business. But because of MNP's advice with the financing options from the bank, he was able to sell to a manager that he liked and trusted and who was committed to the company. He had to wait for some of the money, but the $3.25 million he received up front was more than enough to support a very comfortable retirement at Green Lake.

Key MNP Insights

  • Sometimes, the most logical buyer is a member of the management team who is running the business.

  • The manager may not have access to enough capital to purchase the business, meaning creative financing options, including a vendor take-back, may need to be employed.

  • The success of a management buyout is often based on how well the new owner can drive revenues and profits.

  • There are new options available from banks, including cash-flow lending.

Is it time to start training your successor?

For more information on how MNP can help you plan for succession, contact Shane King, CPA, CA, National Leader, Succession Services, at [email protected]