A long-term plan for business succession and the resulting succession process are crucial to ensuring a successful transaction. As a rule, such a structured process takes at least 6 to 12 months. This process is often used to “spruce up the company” and thus present it as an attractive target for potential successors.
One-time effects fade away; sustainable effects inspire
If the transaction period is used to implement optimization measures related to the company’s balance sheet or earnings structure, these will be identified at the latest during the due diligence process and do not provide a sustainable basis for increasing the company’s value. Examples of such short-term optimizations include the reversal of provisions (other income), the “collection” of outstanding receivables, or the withholding of investments and material purchases.
Long-term, effective measures can maximize enterprise value
As part of the business succession process, long-term, effective measures to improve the balance sheet and earnings structure should be implemented early on in order to increase the company’s value. Within the succession process, the company’s sustainable profitability and debt-to-equity ratio are essential value drivers. As a rule, three to five actual fiscal years of the company are analyzed during the business succession process; consequently, based on this multi-year perspective, only long-term effects contribute to increasing the company’s value.
For example, by improving purchase and sales payment terms, working capital—that is, the liquidity tied up in the company—can be reduced, allowing a larger amount of liquidity to be distributed as part of the succession planning. The successor also benefits from these effects, making this a positive value driver in the context of business succession. Furthermore, repaying debt using current profits reduces the debt-to-equity ratio and thus increases the company’s attractiveness for the succession process.
Reviewing the Cost Structure Enhances Sustainable Profitability
Sustainable profitability, in particular, is the key factor in determining the company’s value as part of the succession process. Regardless of whether an income approach or a multiple approach is used, the company’s value corresponds to a multiple of the company’s sustainable earnings.
The earnings structure can be improved either by increasing revenue or by reducing costs. Revenue growth is not solely dependent on the company itself but is also influenced by economic and competitive factors. Cost structures, on the other hand, can be altered through business decisions. Therefore, the analysis of cost factors should begin early on in order to eliminate costs not essential to operations for the purpose of business succession, increase sustainable profitability, and consequently optimize the company’s value.
Business Succession and Valuation—The Earlier, the Better
When business succession is on the horizon, it is generally important to note that a structured succession process takes at least several months. Thorough preparation significantly increases the likelihood of a successful business succession.
To ensure that the highest possible business value is realized as part of the succession, an early analysis of the company’s balance sheet and earnings structure is necessary. Long-term measures, which should be initiated well in advance of the succession process, can optimize the company’s sustainable profitability and balance sheet; this effectively “spruces up” the company in the long term, making it a more attractive target for successors. As part of the transaction, three to five of the company’s annual financial statements are typically analyzed during the due diligence process. Consequently, short-term adjustments stand out as “artificial,” and at the same time, by initiating measures to increase the company’s value early on, the company’s performance in the context of succession can be gradually improved. As a general rule, the earlier value-enhancing measures are initiated, the more effective and credible they are for the business succession process.
In general, the reason for the valuation is of essential importance when conducting a business valuation and should be communicated early on in order to identify the appropriate valuation methodology. When planning succession for family-owned businesses, it is important to distinguish whether the succession is intended to be internal or external. As part of an IDW S1 valuation report, the individual enterprise value is then determined based on company-specific factors and a multi-year financial projection. Such a report—prepared by a qualified expert—is recognized by both courts and regulatory authorities and simultaneously provides a transparent basis for negotiations in any transaction.
