The Critical Thing Entrepreneurs Rarely Consider…Until It’s too Late

You may have heard the phrase, «Starting something is not as important as finishing it.»

This axiom holds true for virtually every element of life – whether it’s physical, emotional, spiritual, personal, or professional.

However, «finishing» is one of the last things that entrepreneurs and business founders consider when starting a business and running it. They typically don’t give much thought to succession planning until they’re ready to retire.

Entrepreneurs – great at business planning, lousy at succession planning

In fact, a study conducted by Wilmington Trust found that nearly 60 percent of privately held businesses have not even considered succession planning. Additionally, a statistic from Wisconsin-based estate planning firm, the Walny Legal Group, found that 60-70 percent of small business owners want to pass their operations on to their progeny, but less than 15 percent ever do.

The Wilmington study also found that owners who have considered an exit strategy for themselves want to ensure the following three priorities are addressed during any transition:

1. Making sure the company remains viable in the long run.
2. Ensuring that employees continue to have jobs and a future with the organization.
3. Continuing to seamlessly meet customers’ needs without any disruption of delivering products or services.

Given these needs and the lack of succession planning for more than 8-out-of-10 owners, what options does a founder have for something they’ve spent all their life building?

Sale of the business in part or in full

If no one in the owner’s family wants to run the business, selling all or part of it is usually the first exit strategy that comes to mind for most business owners since it’s the most obvious option. However, timing is a critical factor for this strategy, and selling now does not appear to be the best time.

According to the 2020 BizBuySell, 68 percent of surveyed business owners believe they would have gotten a better value if they had sold in 2019 compared to 2020, which is nearly double the response percentage for the 2018 survey – and 7-out-of-10 owners blame the pandemic for their lower estimates in business value.

Business closure or asset liquidation

Small businesses that have been able to pivot, re-invent themselves and survive during the pandemic have been gobbling up struggling competitors, distressed assets at deep discounts, and the corresponding market share.

It’s definitely a buyer’s market for small-to-medium-sized companies trying to stay open through the pandemic cycle. The BizBuySell survey found that 57 percent of prospective business buyers believe they can now acquire a business for a better value than the same time last year, which’s a dramatic jump from 17 percent in 2019.

Additionally, closure and liquidation at fire-sale prices could be difficult for owners to consider in light of the impact on their lifelong work as well as their aforementioned priorities of keeping the company running, keeping workers employed, and customers happy.

Employee-owned alternatives

However, there is another owner exit strategy that increases the chances of keeping the company operational, keeping employees on the job, maintaining business continuity for customers as well as providing a tidy ROI to the founder – conversion to an employee ownership model. The most popular employee-owned options include either an employee stock ownership plan (ESOP) or a worker cooperative model.

Employee-owned corporations are companies where the majority stake is held by the “rank and file” workers. For either an ESOP (pronounced EE-sop) or worker cooperative, the purchase of the owners’ shares of stock on behalf of the employees is accomplished by a loan underwritten with the company’s assets and future profitability.

The specific provisions of an ESOP can be customized to the organization’s needs, but the workers’ shares of stock are held in a retirement trust in all cases. Shares of stock are allocated to employee accounts in the trust each year, and the allocation formula is typically based on their wages and/or years worked. The value of the shares in an employee’s account increases or decreases each year based on profitability and overall market conditions.

Once an employee resigns or retires, they cash out the value of their vested shares by having the company «buy back» the vested shares from the departing employee. Depending on the plan design, the money from the purchase goes to the employee in a lump sum or equal payments over time. Once the company purchases the shares and pays the employee, the company can redistribute the shares to the remaining employees.

In a worker cooperative, in addition to the corporate loan used in an ESOP to get it going, there is also normally a small financial buy-in by each «worker-owner.» This buy-in gives the worker cooperative its distinct “1 share, 1 vote” characteristic, which provides more democracy within the workplace than most ESOPs. A focus on the annual sharing of profits rather than the allocation of additional shares of stock is also a unique feature of worker cooperatives.