The Commercial Client Conundrum
A succession plan for your commercial relationships
By Michael J. Fleischhauer, CPA, CFP, Financial Planning Partners, LLC
As published by the Florida Bankers Association February 2015
Banks risk losing their commercial client relationships anytime one of their business clients decides to sell or otherwise monetize the equity in their business. The baby boomer population owns 66% of all domestic businesses¹. Imagine the 58 year old business owner who relies on their bank for credit and perhaps other services such as payroll & merchant services, asset management, insurance, treasury services, etc. Now imagine that this business owner has decided to exit their business in the next 2-7 years. They’ve owned their business for some 20+ years. Its’ been good to them. As a result of having invested in their company all these years, most of their net worth is derived from the value of the company. The owner is starting to get a little tired and beginning to lose the fire in the belly they once had. They begin to envision themselves doing something else with their time. This scenario is being played out daily with our aging baby boomer population. As a result, banks need to ask themselves one very important question: Is the bank prepared to assist the business owner with the transition of their business? Will the business owner even mention this to their bank in fear that their commercial relationships will be at risk once the bank knows that they are thinking of leaving? The business owner will need help to transition out of their business, they will seek out that help and they will find it somewhere. When they do, will the commercial relationships and all of the other services the bank provides to the business and the ownership group on the personal side be at risk of being lost? The short answer is yes. The next ownership group will establish corporate credit relationships somewhere The group who advises and assists the current and future ownership groups with transition financing will ultimately be in line to extend and facilitate corporate credit, asset management, insurance, etc. for both the new and former ownership groups.
So what’s really up for grabs or at jeopardy of being lost? First, the existing relationships that banks have with the exiting shareholders (both personal and business relationships) are certainly at risk. Second, the opportunity to establish relationships with the new shareholders is at risk. So what can a bank do to mitigate these risks? There is an old proverb, “The prudent see danger and take refuge but the simple keep going and suffer for it.” The need for business planning services quickly comes to the forefront as the solution to the problem. Business planning provides a great opportunity for the prudent to capitalize on this highly undeserved market of existing clientele. So what are the opportunities that business planning offers? One of the most important questions a business owner will need to ask themselves is, “where will the funds actually come from to buy me out?” By offering business planning services, the existing banking partners can be well positioned to provide the client with the appropriate exit financing strategies. Strategies such as traditional commercial loans, SBA loans, insurance based financing strategies among others. What’s more, once the business owner receives cash for their business, either over time or in an immediate cash out and move on scenario, the next question becomes “what will I do with the funds from the buy-out?” The former owner will likely do one of two things with his new found cash, each of which can benefit the existing banking partners. First, if the business owner is truly retiring he will need to look for new income solutions to support his post business lifestyle. Asset Management and insurance services are often utilized to meet these income needs. Second, if the business owner is not ready to retire he will more than likely seek out other business opportunities to invest in, which will require a commercial relationship with a bank (hopefully the existing bank).
Each bank needs to ask itself the following questions: If our 58 year old business owner decides today to transition the company to two key employees in the next 4-5 years will they tell us? Better yet, will the bank proactively approach their clients to offer their services to the company and its current and future shareholders? Huge opportunities exist for banks to enhance existing relationships through lending, asset management, insurance, commercial products, etc. So who are the clients a bank should approach? We have found that the best suited candidates for such services are those companies with going concern values of $1- 10 million. Business brokers and other types of transaction intermediaries serve the lower end of this spectrum and below. While Capital Market groups and the 3,300 Private Equity Firms in the U.S.² service primarily the small and middle markets with enterprise values above the $10 million mark. So the heartbeat of America, business owners with company values of $1-$10 million are the best opportunity. One strategic partner ROCG America’s suggests that the ratio of business owners’ liquid assets compared to the potential monetized value of their business is approximately 1:5. In other words, for every $200,000 of current assets under management that a business owner has there is an opportunity for at least another $1M of assets to manage if their bank can help them achieve their goals and exit their business the right way.
If the exit financing can be addressed by their banking partner the question still remains, “how do I get the organization to run without my leadership and guidance?” Banks may consider a planning platform to provide clients the necessary tools to help business owners address personal financial, estate, as well as business succession and exit planning. Inevitably, outside introductions of advisers may be necessary to render the organization non-owner dependent when the business owner feels they cannot accomplish this on their own. This can be streamlined internally and with assistance of outside advisers who can provide the resources to assist the business owner for those areas where the business needs assistance in order to be prepared for transition. At times multiple projects are identified and the work often needs to occur over a multi-year period.
In many cases business owners in general are not prepared for a transition due to the following reasons:
a) The business is too dependent on the owner for key functions
b) The owner’s livelihood is dependent on the business
c) Key management is not being groomed to lead
d) Business value is not viewed as a financial asset or strategy to bridge the retirement gap
e) The Business is not staged the way buyers would like to see it
f) Business owners are not educated on the process g) Planning is complex and requires a multi-disciplined approach
The most important components of a transition are:
a) Maximize business value (unless gifting to family)
b) Minimize taxes
c) Control over how and when to exit
All the issues above can render the company unmarketable to some degree and business owners are often unable to receive adequate value to pursue an exit based on their true financial needs analysis when there is a lack of planning. Conversely, a company will command the most in an offer price when the company has rendered itself non-owner dependent from the day to day operations and when proper procedures and operating systems are implemented for operational and cash flow sustainability.
Banks have a tremendous opportunity ahead of them as a result of the wealth transfer effect of the baby boomer generation. When proper resources and infrastructure are in place, banks will have the ability to dramatically increase retention and growth among their existing commercial and personal relationships.