Business succession: How the baton is passed in medium-sized firms

November 2020 – In the time period from 2018 to 2022, there were, or will be, around 150,000 Germany companies facing succession. It is becoming less and less common for the new boss to come from the same family. This makes the financing of this existential transaction particularly challenging.

“Like father, like son (or daughter)” has not been the case in German medium-sized firms for a long time now. Family-internal succession is the model of choice for barely half the medium-sized firms in Germany. In addition, more and more company heads remain childless – or their offspring simply have no interest in the directorial position, or they are not suitable enough.

It is commendable when children and parents equally accept that their own offspring are not the optimum line-up for succession. Ultimately, it is not so much about keeping the family honor but rather about passing on a good future to a successful, established company and the jobs and employees dependent on it. Especially in financially-challenging times, this principle applies: first the company, then the family.

An increasing number of suitable candidates for the new directorial position are also being found outside the family – both inside and outside the company. According to the IfM (Center for Small and Medium Sized Business Research) in Bonn, in 29 percent of the cases, investors from outside take the helm through a management buy-in (MBI). And in 18 percent of the cases, the successors are already working in the company beforehand, and then mostly take it over as part of a management buy-out (MBO). Mostly they are employees from first- or second-level management who have been trained for years, and who know the company inside and out with all its strengths, but weaknesses too. They usually enjoy more trust with the old boss and workforce than external buyers. However, since they know the company in detail, they can also dictate the selling price more strongly. Hence, it is not possible for the outgoing director to extract the maximum. But that shouldn’t be the objective anyway, because it is necessary to balance the company’s future and sales revenue. Nobody handing over a company would be happy to maximize his assets, but in return leave his life’s work to its own fate with financial difficulties.

Office with working persons

High demand for capital and guidance for the succession

Company-internal successors usually have to fall back on more borrowed capital for financing and available funds. Thorough preparation and good advice is necessary for this. “Outsiders who take over, who still are found in almost one in three succession plans, also usually have a major need for capital and appropriate guidance,” says Thomas Jakob knowingly. He is Head of Corporate Banking & Advisory at the Hamburg Commercial Bank and one of the hosts at the leading trade fair dealing with company transactions, succession and financing: “Structured Finance”. Due to the coronavirus pandemic, this year it is taking place from November 23 to 26 as a virtual event for the first time. In its own words, the trade fair that has been taking place since 2005 has the highest CFO density in Germany.

According to an IfM study, the matter of succession will be tackled by around 150,000 German medium-sized firms in the time period from 2018 to 2022. “If you take the number jobs into consideration – around 2.4 million – the yearly investment activity, and also the innovative strength and hence the future orientation of these companies, it quickly becomes clear that in addition to the strategic importance to the individual enterprisers and the individual companies, this is topic of the greatest economic significance for Germany as a whole,” says expert Jakob.

Two persons working in a carpentry

It’s all about passing on the work of a lifetime

Succession variants that lend themselves to a successful handover are manifold: In addition to the family-internal solution, the MBI and MBO, foundation solutions or collective ownerships are also possible. “What's more, time and time again questions emerge about protecting the existing shareholders and a stable structure for continuation in new hands. Emotional aspects, such as passing on the work of a lifetime, often make the topic difficult as well, so that it is easy to postpone, and profession outside expertise is called for,” reports Jakob from his longstanding consulting practice.

From a buyer's perspective, the financing of the takeover plays an important role. It is necessary to keep the financing stable at an operating level or to restructure it. “Suitable acquisition financing should be in harmony with the strategic orientation of the company, not overwhelm the buyer, and enable enough flexibility for a fair selling price for the existing shareholders,” says Jakob.

However, numbers aren’t everything, especially for locally-situated, medium-sized firms with a long tradition. “The best purchase price and the best financing structure will not come into play if the shareholders’ interests in jobs, regional responsibility or also any other long-term orientation of a company are not taken into consideration beyond the sale,” says Jakob.

In his own words, the following are needed above all for the important topic of business succession: sufficient time, expert advisors and enterprisers who address this strategic new course at an early stage. The Association of German Chambers of Industry and Commerce (DIHK) recommends, for example, starting the specific planning and search for a successor at the latest three years before the handover.

Family-internal succession still dominates

Chosen succession solutions in German medium-sized firms in percent

Chosen succession solutions in German medium-sized firms in percent (Source: IfM Bonn, 2020)

10 tips for succession planning

Start early, work on it time and time again – that’s how a successful generation change works.

1. Address the topic of succession at an early stage

Senior directors should start planning the succession by their mid-fifties at the latest – and to discuss this with potential successors.

2. Separate the shareholder and company side

The succession of the owner is at least as important as that of the operational management. And both initially have nothing to do with each other.

3. Think about tax and inheritance law

Siblings often have to be paid out or company shares transferred within their lifetimes in order to save taxes.

4. Imagine the company without the family

Directors should ask themselves the question: What business decisions would you make differently if there were no family? This mental exercise helps with the succession.

5. Imagine the family without the company

This also applies the other way round: What would it be like in the family if there were no company? Would decisions be made differently? How?

6. Choose the successor according to ability

The next self-test: What professional skills does the successor have to contribute? It sometimes turns out that nobody in the family can provide this.

7. Let the successor go his own way

Even the children of enterprisers should be able to gain some initial experience outside the influence of their parents. And, also be allowed to then contribute this experience.

8. Don’t leave the successor alone

At the same time, senior directors should not overburden the successor, and stand by him with advice and assistance on request.

9. Be open to alternatives to a family solution

Enterprisers should always consider the sale or succession by an employed managing director. That is how they optimally prepare the internal solution.

10. Get external advice

The generation change is one of the biggest challenges for a family business. An external coach, the tax consultant and banking advisor can help.