Corporate successions

corporate deal photoA topic closely related to M&A is corporate successions. These transactions have a special importance in Germany. For example, in Baden-Württemberg only, about 11000 medium sized companies are available for succession each year.

The main objective of a succession is to ensure continued economic existence of the company and the maintenance of jobs. It can take 2 basic forms.

1. Internal successor

The first form is when the company is transferred to someone inside the family, for example through inheritance. In this case, agreements regarding the other heritors, the liabilities to be taken over, and others issues must be reached.

An alternative is to sell the company against a one-time payment. The advantage of this transaction is that the money is received immediately and it is not dependent on the future paying ability of the successor.

The transfer can also be made against pension or other recurrent payments.  This arrangement is good for the company taker because he/she might not have enough money to make a single payment. It is also good for the transferor as he/she can ensure his/her pension needs. However, measures must be taken to reduce the risk of an uncertain purchase price that can be determined by the economic success of the company.

2. External successor

The second possibility is that the successor is someone out of the family. Many variants exist:

MBO (Management Buy-Out): It occurs when the management of the company takes over the firm and it represents the willingness of management to take risk. It is positive in that the management already know the company well.

MBI (Management Buy-In): It occurs when the company is taken over by a management that does not pertain to the company.

Leasing: This possibility arises when only small machines, tools, warehouse and transportation mediums are sold and the rest of the company is leased. After the end of the contract, the owner can reactivate the business, continue leasing it or transfer to his/her children. From the perspective of the lessee, leasing brings the advantage of not requiring higher purchase price financing.

Gradual transfer: The successor can first integrate the company as an employee before transferring him/her the company in a later stage. This process allows him/her to prove his/her ability without immediately taking all the responsibilities.

Purchase of business shares: This occurs if the company is a corporation.

For a successful corporate succession, the owner of a company must start preparations as early as possible. He/she must find the right successor; verify the candidate’s qualifications, personality, strategic competencies, motivation, flexibility and persistence. The owner must also train and inform the successor about the location, clients, workers, costs and revenues, competition and contracts. Furthermore, the psychological component should also be taken into account so that obstacles can be resolved early. The successor could for instance present his plan for the future and get to know the workers. Changes to the firm should only be introduced prudently while trying to connect them to the company traditions.

Some important aspects to take into account during a corporate succession are: company valuation, legal and financing considerations.

Company valuation

  • German Income Approach: It takes the future excess revenues into consideration.
  • Substance cost approach: It is the resulting amount from the sum of assets minus liabilities. The operating assets are valued assuming they are repurchased and the non-operating assets assuming that they are sold.
  • Averaging procedure: A value is obtained by taking a weighted average from the income approach and the substance cost approach.
  • Liquidation value approach: The value comes from the proceeds that could be obtained if the assets were to be sold separately.
  • Stuttgart procedure: It is an alternative procedure that simplifies some important parameters from the valuation.
  • Comparable method: A comparable is used and adequate adjustments are made.
  • Multiplier method: The value of the company is estimated by using a multiplier of an indicator.

Legal aspects

  • Type of deal: An Asset deal must be distinguished from a share deal.
  • Use of company name: The name of the company can only continue to be used if it is registered in the Commercial Register and the operations are not going to be altered
  • Transfer of liabilities:
    • If the name of the company continues to be used, previous liabilities are transferred to the purchaser, but the transferor will also be responsible until 5 years after the transfer. However, a contract excluding the liability can be made, in which case it must be registered in the Commercial Register and made public or the creditors should be made aware of the situation.
    • If the name of the company is not further used, then the purchaser is not liable for prior obligations.
    • In the case of small businesses, the purchaser is in general not liable for the obligations of the seller, except if a contract so stipulates and the creditors agree.
    • Taxes: The purchaser is liable for the taxes of prior years if the owner is not reachable.
    • Labor contracts: All labor obligations are transferred, but the owner is also liable if the labor costs have arisen before the transfer and are due in one year. From April 2002, the owner and the future owner are obliged to inform the employees by written of the reason of the transition, as well as the legal, economic and social consequences.
  • Current contracts: For the purchaser to be able to enter into current contracts, he/she must have the permission of the third party.
  • Insurance companies: They should be informed early so that the seller can know when he can terminate the contract and the buyer knows in which contract he can enter as well as his rights and obligations.
  • Non competing agreement: It is of the interest of the purchaser that the seller does not engage in a competing activity; however, such a contract can have a maximum duration of 2 years.
  • Testament: It can be a private or a notarial testament. This can be re-written at any time, except when it is a joint testament from the spouses, in which case a change is only possible with the agreement of both parties.
  • Legal claims from close relatives: The owner can choose to whom he/she wants to leave the inheritance to; however close relatives have a legal right to a portion of the inheritance and some agreement must be made on how to deal with these claims.

Financing considerations

A common reason for succession failure besides the lack of leadership experience and industry knowledge of the successor is the financing difficulties.

These preparations should also be done early. A credit institution should be approached as early as possible and documents should be well prepared. In general required information includes personal information, business concept and planning calculations such as capital needs, revenues expectations, and liquidity planning. To obtain the financing, collateral might be necessary.

Creditworthiness is a determining factor in the financing process and can also affect the interest rate at which funds are obtained. There are two channels that detect creditworthiness.  On the one hand, the bank produces its internal rating by reviewing aspects such as management, market, industry, clients, economic conditions and further company development. On the other hand, an external rating by a rating agency can be produced. Even though they are generally only valid for 1 year, it can allow a company to obtain better financing conditions by being in a better position to negotiate. Further, it gives a better company image, as it gives a quick impression without the need to go into the details of the company.

Reference: 

Industrie- und Handelskammern in Baden-Württemberg (2002) Herausforderung Unternehmensnachfolge. Heilbronn – Franken: Baden – Württembergischer Industrie- und Handelskammertag.

Photo by ganderssen1