Business Succession Planning and Ownership Transition

2. Business Succession Planningand Ownership Transition Harry Cook, C.A., CMC Senior Manager, Consulting Services Scott Estabrooks Area Manager, Business Development and Portfolio Development

3. BDC Overview

4. BDC MANDATE: “To assist with the start-up, growth and development of Small and Medium Sized Businesses” Two Streams: Providing Expertise (Consulting) Providing Financing

5. BDC’s Client Support Model Business Development* Consulting Financing Maturity Rapid Growth Slow Growth Survival/Stabilization Start up *Source: “The five stages of small business growth,” Neil Churchill, 1982, Harvard Business Review, “Five stages of growth revisited,” Center for Creative Leadership

6. BDC Consulting Services Provide consulting solutions at two levels: Consultant-in-Residence • Focuses on smaller businesses • Typically BDC clients who’ve received financing under $250k • Consulting services custom designed and priced for smaller businesses External Consultant Network • Focuses on SME’s that require specialized solutions (i.e. Transition, Productivity, Strategic Planning, Feasibility Studies, HR, ISO, SR&ED, Lean Manufacturing etc.) • Consulting services designed for Value Creation and growth • Each consultant in the network has been selected as “best in their class”, are specialists in their area of expertise and represent a wide variety of skill sets.

7. BDC and Business Transition

8. Introduction to Transition “Transition” in this presentation is discussed in terms of exit strategies and change of ownership What does "Transition" mean • The term "Transition" reflects the experience that both the current owner(s) and the buyer(s) will live through when change of ownership of a business occurs • “The passage from one place or state into another; change.” • Transition is a process “over time”, not simply a transaction at a “point in time”.

9. BDC and Business Transition Why is Business Transition important? • Being unprepared or poorly prepared for business transition can have a detrimental impact on the company and the community: • Lower productivity • Potential job losses or • Increase in business failures • A well prepared business transition plan has a positive impact on the company and the community -Business continuity and growth -Optimize value -Innovation

10. Introduction to Transition • We know it isn’t easy, it’s a sensitive issue. • Like writing a will • Facing mortality • Sellers are “Selling their past” • Buyers are “buying their future” • Lots at stake…

11. Introduction to Transition Why is an effective transition important to the business owner?Potential benefits to SME Owners: • Financial stability/continuity • Increase the value of their businesses • Leaving a legacy – something living beyond their active involvement

12. Introduction to Transition Owners’ Objectives: • Successfully pass a business to the new owners and ensure its continuing success while supporting personal and financial goals • Optimize selling price, minimize tax implications, minimize risk and maximize return to current owners. • Optimize the opportunity for continuity and the success of the new leadership/ownership, including the training of successors to assume leadership

13. Transition Planning The ultimate transition planning test happens when the key manager(s)/owner(s) leave and divest their interest in the business. Are Canadian SME’s well prepared for this test?

14. The Demographic Snowball

15. Demographic SnowballPopulation Pyramid

16. Demographic SnowballSize of the cohort • The “Baby Boom” generation - 32.7% of Canada's total population. • Struggling in its shadow is the “Bust Generation" or “Generation X” - 18% of the population or only 55% the size of the Boomer generation. • Hot on its heels is the “Echo Generation" or “Generation Y” - children of the boomers - 23% of the population or only 70% the size of the Baby Boomer generation. • Shown graphically, the baby boom looks like a giant bulge in a population graph.

17. Demographic Snowball BIRTHS PER YEAR % Inc Pre WW I Pre 1914 201,000 births/yr WW I 1914-18 244,000 births/yr 21% “Roaring 20’s” 1920-29 249,000 births/yr 2% Depression years 1930-39 236,000 births/yr ( 5%) WW II 1940-45 280,000 births/yr 19% Baby Boomers 1946-65 426,000 births/yr 52% Bust Generation 1966-79 362,000 births/yr (15%) Echo Generation 1980-95 382,000 births/yr 6% Children of the bust 1996-on 344,000 births/yr (10%)

18. Demographic SnowballSO WHAT?What Is The Relevance Of This From A Business Point Of View? Average number of Baby Boomers per day reaching the traditional retirement age of 65 in 2011: 1,150 This compares to the number per day of the previous generation (born during WW II) when they reached 65 starting in 2005: 750

19. CFIB Study – Time factor When do SME owners plan to exit their business? Highlights… • 71%of SME owners plan to retire within 10 years. • Only 35%of businesses have a transition plan and only 7% of owners have formal plans. 71% % 4,311 respondents - (% of answers, years) Studies conducted by the Canadian Federation of Independent Business with SME owners, June 2005

20. PUTTING THIS INTO PERSPECTIVEMagnitude of Transitions(Nova Scotia) Total Number of Businesses 32,000 Number of small businesses (>50 employees) 29,000 Number of Businesses changing hand in the next 5 years 12,000 Number of Businesses changing hand in the next 10 years 21,000

21. CFIB Study – Method • Howdo SME owners plan to leave their business? Most entrepreneurs (37%) plan to sell their business to non-family members Winding down of activities Other Sell to family member Transfer to family member No plans yet Sell to non-family member Studies conducted by the Canadian Federation of Independent Business with SME owners, June 2005

22. Lack of Planning • The lack of a Transition plan • 65% of entrepreneurs have no transition plan • Among those who have a transition plan,only 51%have chosen theirsuccessor • Non-family businesses are more likely to have a transition plan than family businesses (39% vs. 29%) Studies conducted by the Canadian Federation of Independent Business with SME owners, June 2005

23. CFIB Study – Employment SME transition and employment in the next 5 years • Among the 41% of owners who will leave their business in the next 5 years, only 15% will create anew business. • According to CFIB, the remaining 85% who will exit (about 340,000 owners) will affect 2 million jobs if nothing is done to facilitate the transfer of these Canadian businesses. 41% = about 400,000 businesses % Years Studies conducted by the Canadian Federation of Independent Business with SME owners, June 2005

24. Benefits of Planning The main benefits of planning, according to SME owners: • Provide for the family's future needs • Reduce tax obligations • Give the business financial stability • Maintain harmony within the family or with employees • Prepare their successor for the future • Increase the value of the business Studies conducted by the Canadian Federation of Independent Business among SME owners, June 2005

25. Benefits of Planning (cont’d) The main benefits of planning, according to successors: • Prepared me to be a business owner • Provided financial stability to business • Improved financial standing of business • Fostered family/employee harmony • Minimized personal financial liabilities Studies conducted by the Canadian Federation of Independent Business among SME owners, June 2005

26. Risks?

27. Risks from not planning Risks and negative effects resulting from a lack of planning: • All stakeholders are put at greater risk • The value of the business may not be optimized • Key individuals feel vulnerable and may leave • Exit options are limited • Assumptions regarding the future goals and visions of other stakeholders is hazardous

28. Life Events Unexpected Triggers? - Life changing events: • Heart Attack, • Stroke, • Major Disability, • Lightning Strike!

29. CROP Study–Findings • Why such a resistance to planning? • Emotional link (it’s their baby) • Fear of losing their “raison d’être” • Entrepreneurs don’t plan, they act • Short-term focus (crisis management) What issues are important to SME owners? • Benefits: viability and protection of the business • It’s a long thinking process • Health (theirs, as well as the health of their spouse and associates) • Not a “one-size fits all” approach

30. CROP Study Entrepreneurs on thinking of transition planning: • “I know my sons could take over, but they’re not interested, so I have to come up with a plan B” • “I’m much too busy at building my business. I don’t have time to think about selling!” • “I am working in a small service business; the value of my business is related to my client network and experience; if I leave, this value will be drastically different“ • “I can’t afford to retire, so I don’t even want to think about it” • “Thinking of transition is not easy because if you have a few children not equally involved in the company, it can become very emotional and you just don’t want to deal with that.”

31. CROP Study Accountants on their clients thinking of transition planning: • “Very difficult to get them (clients) to deal with it. If you were dealing with a new client, transition would never be in the top ten things you’d discuss. You have to have a pretty strong relationship to be able to deal with it.” • “To get them through to a fair realization of what it’s worth and to have reasonable expectations, where’s the financing going to come from, are you willing to do a vendor take-back, what’s the timing of it; they’re overwhelmed, they’re blown away, all the time” • “… It’s always a life event that triggers it…”

32. Transition Planning Technical Elements: • Legal transfer of the business ownership • Tax implications of disposing of the business • The financing of the successor • The division of future profits under the transition.

33. Soft Issues are the Hard Issues: • Identifying long-term personal and business goals, • Developing strategic and operational plans to maximize value in the business, and ensure a smooth transition • Communication of each stakeholder’s vision for the business (owner, employees, family, successor) • Selecting and training the successor. • Determining each person’s role in business after succession and preparing key people for their role during and after succession

34. Start with your vision – Hard Questions, Powerful Answers Where do Iwant to be (my Vision for the future)? Where do we want the business to be (Vision for the Enterprise)? Where are we now?(current performance/state of the enterprise and industry) What factors are impacting our current and future performance?

35. Realistic? • Is my vision for the future, reasonable, based on analysis? • What are the gaps between now, and the desired future state? • How are we going to get there? • Who is going to do what? • How do we monitor for success?

36. Business Transition:Realizing the Value of Your Single Biggest Asset CLARITY…LEADS TO POWER Compared to business planning, succession planning requires a more structured approach.

37. Are entrepreneurs a bit anxious?

38. The Main Obstacles For the current owner Financing for the successor Finding a buyer/suitable leader Too much dependence on my involvement Valuing the business Conflicting vision with family Access to cost-effective advice Other Conflicting vision of employees In both cases, financing represents the main obstacle For successors Financing the purchase/transfer Valuing the business Getting the owner to “let go” Access to cost-effective advice Other Conflicting vision of family Dependence on previous owner Conflicting vision of key employees Next to financing, the valuation of the business is a significant barrier Studies conducted by the Canadian Federation of Independent Business with SME owners, June 2005

39. Sources of Transition Financing:

40. Financial Due Diligence • Particular Elements of importance to lenders in a change of management or ownership • Competencies and Experience of the new management • Client Loyalty • Management Control Systems • Company Dynamics • Will seller assist the management during the transition • Capacity of new owners to reinvestNote: All of these elements are covered in the strategic/transition plans

41. Challenges for all of us • Sellers reduce their investments • Take equity out for retirement • Reduce spending on long term payback projects • Buyers lack resources to invest • Debt is higher in business • New spending on technology, equipment and R & D is reduced • Lack of planning reduces the options for buyers and sellers

42. The Legacy?

43. Valuing the Business • Two Values • Liquidation Value – net amount realized on liquidation of net assets • Going–Concern Value – mainly concerned with the future returns from the investment • Tangible Assets • Accounts receivables – at net realizable value • Inventory – at lower of cost or net realizable value • Land, Building, Equipment – fair market value • Intangible Assets • Goodwill, franchises, customer list, patents, licenses, etc. – much harder to value • Goodwill – the difference between the going-concern value of a business and the aggregate net tangible assets of the business – Ability to earn a greater return than is normal on tangible and intangible assets (Transferable Goodwill vs Personal Goodwill!)

44. VALUE CREATION PROCESS Certified Quality Management Systems (ISO, HACCP) Leadership Training Strategic Planning Business Planning Corporate Structure $ Value Creation Sale Date Now $ Owner’s Estate/Tax Planning Human Resources Productivity Improvement (Lean Manufacturing) Financial Services SR&ED Marketing

45. The Result: Increased Business Value

46. Value Creation Calculation There are two basic ways to value a business: • Break-up Value • Capitalized Earnings Value

47. Value Creation Business Valuation Techniques

48. Value Creation Business Valuation Techniques

49. Value Creation Business Valuation Techniques In this example a $50,000 per year improvement in earnings can create a $333,000 increase in the value of the business.

50. What is my business worth?Advice from business valuators… • Get a handle on the current value of your business Drivers: Assets, Income and Market Conditions • Goodwill – of no value unless it is transferable to another party • Other Key Considerations: -Depth and Breadth of Management Team -HR Turnover Rate -Diversification of Products, Customers and Income streams -Re-investment in infrastructure (i.e. plant and equipment) • Bottom Line …EARNINGS are the Main Driver of Value These value considerations, along with personal vision, lead us into a transition planning process