There are numerous challenges in a business succession initiative, with financing being a key issue, as it can mean the difference between a successful transaction or a failure. It can also have a major impact on the business’s medium-term sustainability.
There are several points for the transferor to consider:
- Will the asking price ensure the business’s long-term longevity?
- Will the transferor receive sufficient funds for retirement?
- Is the transferee’s cash outlay sufficient?
- Will the transferor have to invest in the financing structure to ensure the transaction’s success?
Balance of sale price
Generally, the transferee’s outlay represents a small portion of the succession plan financing structure (less than 20%) and usually serves to maintain a balanced financial structure. When the overall transaction value is low, this may be sufficient. However, if the value is in the hundreds of thousands, such a low percentage could prove to be a significant obstacle.
The balance of sale price, i.e. the transferor’s financing, then becomes the best solution to complete the financing structure. Often misunderstood, the balance of sale provides flexibility in the financing structure and a means for the transferor to recover the full value of the business during the first years following the transfer.
The transferees’ results must be as good as those of their predecessors, given the high debt level. Flexibility is an undeniable asset in ensuring a successful business transfer. Sound strategic planning that provides for some growth will make it easier to bear the financing burden.
The right choice
In a succession situation, the transferee’s management skills are a major consideration when obtaining financing. For this reason, a gradual transfer is the preferred option. It allows the transferees to gradually gain management experience and confidence and reassures the lenders about the business’s operations and management. Lastly, it provides the transferees with a gradual participation in the business’s future returns and maintains the transferor’s capital during the transition.
Feasibility of the succession plan
Generally, it can take from four to ten years for transferors to recover the full value of their business, depending on:
- The industry;
- The value of available security;
- The business’s historical and future cash flows;
- The transferee’s financial capacity;
- The transferee’s competencies and the soundness of their succession plan.
A business transfer diagnostic can be a useful tool to shed light on these factors and confirm the succession plan’s feasibility for both parties.
There is a wide range of possible financing scenarios, which is why it’s crucial to talk with the parties to determine their expectations and propose the best financing structure in accordance with their needs.