Succession Risk in Business Sales: A Key Inhibitor to Deals
Succession risk is a critical challenge that can drastically reduce the appeal of a business for potential buyers. This risk arises when a company's leadership is heavily reliant on its exiting shareholder(s), with little to no second-line management team capable of running the business autonomously. While the existing leadership may have the best intentions of supporting a smooth transition, there are several factors that can undermine their ability to continue supporting the business effectively post-sale. As a result, succession risk not only threatens operational stability but also creates significant hurdles in deal negotiations and the eventual sale of the company.
The Impact of Succession Risk on Deal Structure and Pricing
When a business is dependent on its current shareholders for leadership and direction, potential buyers face a considerable challenge. While the exiting shareholders may intend to support the new owners, various obstacles can make their continued involvement uncertain.
The exiting shareholders may struggle with the emotional and psychological shift that comes with stepping away from the day-to-day operations of the business, even if they are still technically involved. Cultural misalignments between the new owners and the exiting shareholders, especially if the business has been built on the charisma, idiosyncracies or personal vision of the seller, can result in friction that undermines operational effectiveness (impacting staff, customers, suppliers alike).
Beyond that, exiting shareholders often face a lack of incentive to continue giving their all to the company, particularly after receiving a significant financial windfall which has extinguished the obligations which previously drove motivation. The long hours, stress, and sacrifices that once drove their commitment may now feel less compelling when they are no longer as financially motivated. As such, there is a risk that they may step back from the business, leaving gaps in leadership and possibly creating a vacuum of responsibility. This can cause significant instability, making the company a riskier investment for buyers.
As a result, buyers may find themselves in a position where they either cannot afford to pay the current leadership enough to stay on (thus risking loss of critical talent) or must offer a reduced purchase price to account for the uncertainty surrounding leadership continuity. In some cases, the potential buyer may decide to walk away from the deal entirely, further limiting the seller's options and reducing the value of the business.
The Range of Potential Buyers is Also Affected
Private equity firms, in particular, are highly selective when it comes to investments. They seek companies that already have strong, autonomous management teams in place—ones that can continue driving the business forward without the constant involvement of the previous owners. For these firms, who see many opportunities, the reliance on exiting shareholders for leadership can often be a deal-breaker. If a business is perceived as lacking a solid management bench, it may significantly reduce the pool of buyers, especially when the company's future success hinges on the continued presence and involvement of the exiting shareholders. This leads to fewer interested parties and the lack of competition ultimately leads to a reduction in price and (or) structure i.e. the the vendor maybe required to stay longer and thus have their consideration paid instead over a longer period of time (rather than on completion) to mitigate the risk of losing motivation.
Mitigating Succession Risk: Proactive Strategies for a Smooth Transition
While succession risk can pose significant challenges, there are many ways to mitigate it and improve the prospects of a successful deal. Addressing these risks head-on with strategic planning and foresight can result in more attractive deal options, higher valuations, and broader buyer competition. Here are several strategies that can help:
1. Long-Range Recruitment Planning
Developing a second-line management team requires long-term planning. This should be a priority for the business years before considering a sale. Identifying and nurturing potential leaders from within the organization can help ensure that the company is not overly reliant on the exiting shareholders. Establishing leadership development programs, providing ongoing training, and offering mentoring opportunities can help build a robust internal leadership pipeline. Over time, the business will develop a team capable of taking over key responsibilities and guiding the company through its next phase, reducing reliance on the current owners.
2. Developing Leaders with Their Own Brand
Successful leadership is not just about technical expertise but also about cultural fit and the ability to make independent decisions. Cultivating leaders who can own their roles and embrace the company's brand is key to building autonomy. This is particularly important in a sale scenario, where the incoming owners will need to know that the leadership team can maintain the company's culture and direction without the constant presence of the former shareholders. Fostering leadership from within and building an internal management brand ensures that the business remains strong and resilient after the sale.
3. Strategic Short-Term Hiring: Fill Gaps Pre-Sale
One of the most effective ways to address succession risk in the short term is by hiring strategically 6-12-18 months before the sale process begins. This approach allows a company to bring in leadership talent that can fill any gaps in skills or experience, ensuring that the business is well-positioned for a smooth transition. This could include hiring specialists in areas such as finance, operations, or sales, depending on the business's known weaknesses or areas of opportunity. By bolstering the leadership team ahead of the sale, a company can present itself as a more attractive package to potential buyers.
4. Management Buy-In (MBI)
An MBI, where an external manager joins the business and also buys a stake, can be an ideal solution for mitigating succession risk. This approach ensures that the new manager has skin in the game and is incentivized to drive the company's success. It also provides the business with external expertise and leadership experience, which can be critical during the post-sale transition. In addition, MBIs can help reduce dependency on the exiting shareholders, as the new management will have a vested interest in the company's long-term growth.
The Benefits of Solving Succession Risk
Addressing succession risk proactively not only enhances the chances of a successful sale but also broadens the pool of potential buyers. By reducing dependency on the exiting shareholders, businesses make themselves more appealing to a range of buyers, particularly private equity firms and overseas trade buyers but also will now include options led-by-management (be that full or partial buy-outs and (or) transition to Employee Ownership).
Additionally, resolving succession risk can help to preserve the company's value and operational continuity long after the sale is complete. By building a strong leadership team and ensuring a smooth handover, the business is more likely to thrive under new ownership, creating long-term value for both the buyer and the seller.