Written by: Gerald O’Dwyer the PE Guru
Introduction
John, a 95-year-old owner of DairyBest Co., a $40 million milk cooperative, is contemplating selling his company to a private equity (PE) firm. With two children in their 60s actively involved in operations, ensuring continuity becomes crucial. To maximize the selling price, his broker advised him to hire and train their replacements earlier.
Benefits of Early Succession Planning
1. Minimized Operational Disruption: Training successors in advance guarantees a smooth operational transition, reducing risks associated with a leadership vacuum.
Example: DairyBest Co. depends on timely pickups from milk farmers. A well-trained successor ensures that these operations continue seamlessly, avoiding losses from missed or delayed pickups.
2. Preservation of Company Culture and Relationships: Established relationships with milk farmers and other stakeholders can be transitioned more effectively when successors are trained and familiarized in advance.
Example: Over decades, DairyBest Co. has nurtured trust with its milk farmers. Introducing successors early allows these relationships to be maintained, preserving supply consistency.
3. Increased Buyer Confidence: PE firms often pay a premium for companies with clear succession plans, as it reduces future uncertainties.
Example: A PE firm might value DairyBest Co. at $50 million with a clear succession plan, versus $45 million without one.
The Math
Let’s assume DairyBest Co.’s current EBITDA (earnings before interest, tax, depreciation, and amortization) is $4 million. PE firms typically value companies based on a multiple of EBITDA. For this sector, let’s assume a valuation multiple of 10x.
Without succession: $4 million x 10 = $40 million
With succession planning: Potential increase in EBITDA due to enhanced operations and buyer confidence, let’s say by 25%: $4 million x 1.25 = $5 million. Valuation: $5 million x 10 = $50 million.
Difference in valuation = $50 million – $40 million = $10 million.
This means John could potentially gain an extra $10 million by introducing and training successors early.
Conclusion
For John and DairyBest Co., early succession planning is not just about continuity; it’s a strategic move that can significantly enhance the company’s value. This can be a deciding factor for a PE firm contemplating the purchase, given the minimized risks and guaranteed seamless transition. For a business rooted in relationships and timely operations, like a milk cooperative, this strategy becomes even more crucial.