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With Baby Boomers aging into retirement, succession plans for IT channel companies is a timely topic. However, experts agree the groundwork for succession should be established before retirement is even a consideration. Those that do so reduce their business risk and have more options when the time for retirement comes.
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"[Succession plans are] not always about retirement, but what would happen if I was to be permanently disabled or die in some catastrophic accident?" said Christopher Hertz, CEO of New Signature, a Washington, D.C.-based systems integrator and managed services provider (MSP). "What would happen if I just couldn't work anymore? What would happen to the company and the value I built in the company, and how would my family be compensated? It's about planning around unpleasant possibilities that exist in an uncertain world."
Hertz doesn't have plans to retire anytime soon, but the measures he has put in place to protect against "unpleasant possibilities" also help him prepare for a future retirement. "The focus of any business owner in terms of trajectory in their career should be on having the key things in place: insurance, management, processes and building strong intellectual property," he said.
According to Charles Weaver, CEO of MSPAlliance, privately held companies have a couple of options when it comes to retirement, but the most common approach is to sell the company to another company, such as an MSP, or to an investment or private equity group. "That's the only way to get equity out of the company if you've been an owner all of your life, unless you've been taking money out and building your retirement. You can do that, but it's not common because most business owners don't run with that type of margin. It's more common to say, 'Hey, do you want to buy my company?' The owner gets compensated and that's their payout," Weaver said. Similarly, he said owners can sell the company to the employees, making it an employee-owned business, or sell it to an individual employee.
"A lot of small businesses are often acquired by someone who is already in the business and knows the value," Hertz said. "Make sure you are developing an energetic company that has lots of smart people, and maybe one day one of those people can be a successor."
Christopher HertzCEO of New Signature
Instead of selling the company and completely walking away, some business owners may prefer to remain involved in a limited capacity and receive ongoing compensation. "You don't just have to sell a business. There are lots of ways to disengage from the business but still have revenue streams," Hertz said.
One way is through a merger. "MSPs are uniquely situated to conduct and pull off mergers where they go to another company and say, 'Would you like to eventually take over 50% of my business? I'll retire and take less of a paycheck but have some residual income,;" Weaver said. "Mergers can be very effective, and I think there's a compelling case to be made that MSPs should be using mergers more than they have in the past."
Unfortunately, any of these scenarios may be difficult for business owners who came into managed services late in their career. "That can sometimes be a problem because they may have a legacy business -- a VAR [value-added reseller] or consulting or project-driven shop -- and only in the last five or 10 years really embraced managed services," Weaver explained. Managed services make up a small portion of the business and don't contribute as much value as they could otherwise.
"We see a number of cases where the valuable business is one-third. Two-thirds isn't something they are getting any valuation for," Weaver said. "We try to tell people, if you are doing hardware and services, you want to do the one-third rule. One-third managed services recurring revenue, one-third managed services non-recurring and one-third hardware/software. That way, you are mitigating your risk and have a good diversity."
Tom McDonald, president at NSI, a Naugatuck, Conn.,-based managed services provider, explained it this way: "The more top-line recurring revenue I have and the more profit I can show that drives, the more valuable my business is, and the more someone can pay me for that."
Regardless of the route MSP business owners take to retirement, good MSP business practices help to facilitate succession plans. For example, Hertz said that doing audits and financials in advance of any M&A activity can mean getting a deal in two months versus six. "Doing your basic blocking and tackling may cost more today, but it will make the business more valuable," he said. "It shows that the business is well run, is audited by a third party, and attests to the validity of the organization."
Weaver also stressed the importance of an audit. "Being able to do a valuation or certification or audit exercise is helpful. If you can pass an MSP certification where a third-party auditor comes in to look at policies, procedures and financials, and can't poke holes in them, then you won't have any problems with a merger or acquisition because you'll have done your own due diligence at some point."
McDonald, who is looking for businesses to acquire as a means of growing NSI, said it is not often that he comes across companies that have their financials and other processes in order -- but that it doesn't have to be difficult. "If you're looking to be acquired and you're doing the basic business stuff well, you'll be in good shape. It's not very complicated. Just do what you're supposed to do. Eat your veggies like your mother said, and you'll be in good shape," he said.
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