Succession Planning for Agency Owners: What You Need to Know

Jesse GiordanoJesse Giordano is a financial advisor and leads The 360 Group at Morgan Stanley in Great Neck, NY. Jesse and his team provide specialized wealth management services to owners of privately held companies who are looking to exit their business over the next 2-10 years. 

Some of the services he and his team provide include helping the owner get his or her business ready for sale, navigating the many exit strategies available to determine which is most appropriate, facilitating the exit process, and implementing an income replacement strategy once the business is sold. 

Jesse has been working with business owners over the last 10 years. He is a CERTIFIED FINANCIAL PLANNER™ and received his MBA from Pace University in 2003. He is also a family wealth director and senior vice president at Morgan Stanley. 

In this interview, Jesse discusses the need for agency owners to start succession planning now, and tips and considerations on how to get started.

Q&A with Jesse Giordano

MAI: Why is it important for agency owners to start succession planning early?

Jesse: Most owners have not started planning for their transition because they believe it is too early. Here is my concern, 10,000 baby boomers reach retirement age per day, and more than half of businesses across the U.S. are owned by them, according to the 2007 US Census.

What will be the impact on these baby boomers’ ability to retire with the majority of their wealth locked in their businesses? With so many business owners being baby boomers, will the generations that follow be big enough to meet the supply of businesses for sale?

Complicating things further, cash on corporation’s books and un-invested cash at private equity firms is near an all-time high. If that cash availability begins to decline over the next few years, what are the implications on price? If the Fed raises interest rates in the future and the cost of borrowing increases, how does that impact the price a buyer is willing to pay for a company if they are financing a portion of the transaction?

Most owners believe that when the time is right they will receive one of the many unsolicited calls they have received in the past, and they will sell to the highest bidder. Unfortunately, the changing demographics may reduce how much the owner is likely to get. Conversely, many believe they will transition the business to their children who will continue to run the business with the same passion and success. However, owners are increasingly telling us that their children want nothing to do with the business.

MAI: What transition options are available to marketing agency owners?

Jesse: It is not unusual to meet business owners who have as much as 90% of their net worth tied up in their businesses. While executives and professionals are funding retirement plans like a 401k, business owners often plough much of their income back into their businesses.

Warren Buffet once said that to become wealthy you need a lot of a few things, but to stay wealthy you need a lot of many things. So the question becomes, how do business owners achieve diversification?

Some of the options include:

  • Sale to a competitor: This may be the most obvious option, but going to your competitor is not the only option.
  • Private equity recapitalization: Private equity funds are playing an increasing role in business transitions.
  • Employee stock ownership plans: ESOPs offer unique tax benefits and allow the owner to stay in control of his or her company while obtaining diversification.
  • Manager buy out: MBOs are agreements between owners and management teams where the business is transitioned to key employees over time in exchange for a pre-determined value.
  • Transfer to heirs and family members: Although family businesses that pass down generation to generation is less common today than it was 50 years ago, it is still a highly tax efficient way to transfer a business.
  • Leveraged recapitalization: This strategy is not a transfer of ownership, but a way for owners to obtain diversification by borrowing from a bank against assets of a company.

Each option comes with different complexities, valuations, tax implications and responsibilities for staying involved in the business. The option that makes the most sense for the owner is typically found at the intersection between the business owners’ financial readiness and their emotional readiness for an exit.

MAI: How do you know which option makes the most sense for a company? What steps should agency owners take now to plan for their exit?

Jesse: Every business owner considering an exit should work with professionals on the following:

  • Assess mental readiness. In this step, we are looking to determine the business owner’s goals for staying involved in the business. Is the goal to “get me out now,” simply create options or to transition slowly over time?
  • Determine your financial readiness and value gap. This step involves comprehensive wealth management, including identifying how much the owner needs after taxes and fees to maintain his or her lifestyle, and developing an income replacement strategy.
  • Evaluate and rate the key value drivers in your business. Explore what buyers are looking for and where the owner needs to focus his or her attention prior to going to market.
  • Evaluate exit options and determine potential valuations for each option.
  • Decide whether you will stay and grow, or proceed with the exit. Weigh all the options from the analysis above and make a decision as to whether to move forward or not.
  • If decision is to stay and grow, determine which key value drivers to focus on and develop a strategic plan to achieve goals.
  • If decision is to proceed with the exit, begin to assemble your exit planning team. Professionals that every business owner may want to consider having on his or her team are an exit planner and financial planner to coordinate the process, an M&A advisor (or business broker), a corporate attorney, tax professional, estate planning attorney and business valuation specialist. You can use the professional that you have used for years, but proceed with caution as the skills associated with helping owners grow their businesses may not be the same skills required to help owners sell or transition.
  • Manage and facilitate the process.
  • Develop and implement an income replacement strategy.  Determine how the owner will replace his or her monthly income with the proceeds. Think about creating a new business with no employees (i.e., an investment portfolio).

MAI: How can agency owners determine what their business is worth? How can they increase the multiple they receive?

Jesse: Owners can use a business valuation specialist to get an idea of what their businesses are worth, but the true value is what a willing buyer and willing seller agree on. That being said, you don’t know for sure until you go to market.

In terms of improving value: A question business owners may want to ask themselves is “Am I a business owner or a business operator?” Buyers are looking for a business that they can grow and earn a profit from, thus they are acutely concerned about risk.

That being said, there are aspects of a business that we refer to as key value drivers, which maximize business value and mitigate risk to the new potential buyer. Some key value drivers include a strong middle management team, consistent financial performance, low customer concentration and barriers to entry, and competitive advantage.

Just as you would dress up your home prior to selling it, you want to do the same for your business. However, this takes time; therefore, business owners should start years in advance. One of my favorite thought-provoking statements with owners is: “If your business cannot grow and thrive without you, than you don’t have a business, you have a job. Which do you have?”

Evaluate and rate the key value drivers in your business. Explore what buyers are looking for and where you need to focus your attention prior to going to market. The motives of a buyer and seller are not aligned. The seller is comfortable with the risk they take, because they have control. However, the acquirer is focused acutely on the likelihood that the business will continue to grow and thrive without the owner in place.

MAI: In succession planning, what unique challenges exist for service companies, and how can owners overcome them?

Jesse: Service companies face the unique challenge that they often do not manufacture a tangible product, thus potential buyers shy away out of fear that the value of the business will walk out the door with the selling owner.

The challenge to the selling owner of a service company is to productize his or her services through branding and the development of a unique process. A unique process that is complimented by “brandable” intellectual property becomes very powerful.

Some additional challenges owners face and common mistakes include:

  • Overestimating the value of the business. They view their businesses through their own lens and not through those of their acquirers.
  • Failing to understand the full impact of taxes and transaction fees.
  • Not taking the time to answer the question: “Is this enough?” Unfortunately, once you exit your business you rarely get a do over. Determine the difference between the liquidity you have today and the liquidity you need to continue your lifestyle. The business value after taxes and fees must fill this value gap if you plan on maintaining that lifestyle.
  • Using their businesses like personal checkbooks for many reasons, making it difficult to understand true profitability. Buyers of a business are looking for a return on investment. If the numbers are not clear or easy to understand, potential acquirers will either reduce the offer price considerably or walk away. That being said, it behooves owners to have their financial statements at the very least reviewed, or preferably audited for the three years leading up to a sale. The integrity of the numbers provides the buyer with confidence that the numbers are accurate.
  • Going it alone. In efforts to save money, business owners will often try to execute the process on their own. It’s important to note that you don’t get a do over and that each mistake may prove costly and unrecoverable. We believe that one of the most important people the owner needs is an exit planner or someone to coordinate the process.
  • Not taking advantage of estate planning opportunities. There are unique opportunities prior to the sale of a business to reduce estate taxes. Some of these strategies take time to implement or can be challenging if not implemented early enough.
  • Believing selling to your competitor is the only option. There are many options with different financial implications as well as requirements for you to stay on. They include ESOPs, private equity recapitalizations, MBOs and transfers to future generations.
  • Not planning your next phase. The idea of spending the rest of your life on the golf course may be exciting for some, but boring for others. Owners who do not think through the next phase of their lives thoroughly often find themselves bored or unhappy six months to a year after the sale. We often tell owners to “never retire from, ”but to “always retire to.” In other words, know where your next phase of life is headed.

MAI: What stakeholders should be involved in conversations if an exit is pending?   

Jesse: The owners, his or her family and key advisors to the owner should all be involved.

How are you planning for your exit? Share your thoughts below.

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