The issue of succession is becoming a challenge for small and medium-sized businesses. According to a KfW study, 227,000 owners of small and medium-sized enterprises plan to hand over their businesses to a successor by the end of 2020. However, around 36,000 of these companies have not even begun their search yet. Given the ever-dwindling pool of potential candidates, long-term planning is of paramount importance.
Entrepreneurs looking to hand over their businesses should therefore consider the following five options:
1) Management Buy-In (MBI)
An MBI involves the takeover of the company by an external management team. The new managers—often supported by banks or private equity investors—acquire a majority stake or even 100 percent of the company. Subsequently, the existing management is replaced by the MBI management team. Bringing in outside investors is often financially necessary to fund the acquisition. A change in leadership also makes sense for strengthening the company’s innovative capacity: The new managers generate ideas that no internal employee would have come up with.
The biggest challenge is finding the right successor candidate for an entrepreneur willing to sell. If the takeover fails, there is a risk that the new managers will use valuable information against the company. Candidates from larger corporations who have many years of leadership experience are often interested in these positions.
Experience in large corporations often pays off in small and medium-sized businesses—since the goal is frequently to expand the company. Existing owners often shy away from taking this step or are unable to manage this phase of growth.
The former owner should also assess the candidates’ skills. It is essential that the new owner come from the same industry—those from outside the industry rarely have a chance to succeed in the new environment.
2) Management Buyout (MBO)
In this form of succession, the group of buyers consists of the company’s employees. This often leads to a boost in motivation among the existing workforce, as they realize that they, too, may one day have the chance to lead the company. In addition, the new owners require less time to get up to speed than new managers would.
This form of acquisition is also more cost-effective because it eliminates recruitment costs. From the previous owner’s perspective, it may make sense to grant a small equity stake in the company to several suitable candidates in advance.
3) External Management
The key principle behind this option is that management and capital are separated. At the Haniel Group, for example—one of the largest family-owned corporate groups—this principle has always been firmly established. External management can be easily distinguished from a management buy-in because the external manager does not acquire any shares in the company, whereas the acquirer in an MBI is also an owner.
4) Foundation
According to experts, the succession model with the longest-term perspective is the establishment of a foundation. With this succession model, preserving the company and securing income are the top priorities. It also offers tax advantages because, unlike a gift, it allows for the avoidance of estate tax.
Typically, the foundation acquires a majority of the company’s shares. The purpose of the foundation is usually determined by the retiring entrepreneur. Even after the entrepreneur’s death, this purpose cannot be modified. This guarantees the company’s longevity.
The founding family can nevertheless exert significant influence over the company’s strategy, as its members often serve on the advisory board. The family can also amend the foundation’s bylaws so that managers from outside the family at the top cannot act with complete freedom. For example, certain transactions—such as those exceeding a predefined investment threshold—can be carried out by management only with the approval of the foundation’s advisory board.
5) Dissolution
If, despite all efforts and searches, no successor—whether external or internal—can be found, the company faces the threat of dissolution. In the case of a limited liability company (GmbH), the following steps must be followed. First, the GmbH must be terminated as an active company. This means the company can no longer conduct its business. Next, the assets are liquidated or distributed among the shareholders. The actual dissolution of the GmbH then takes place upon its removal from the commercial register, provided that no assets remain.
