Klassik Radio Special · Business succession in the German SME sector

Klassik Radio

Welcome to the Klassik Radio Special, today on the topic of business succession in the SME sector. My guest is Dr. Nikita Gontschar from our partner GxG Legal. He advises companies on all matters relating to corporate law, M&A and succession, and I am sure he can answer all my questions on the subject. Dr. Gontschar, it is great that you have the time.

Dr. Nikita Gontschar

Thank you very much for the invitation. I am pleased to be here today.

Klassik Radio

When people think about succession, they often first think of inheritance within their own family, the next generation. How has that perspective changed in recent years?

Dr. Nikita Gontschar

It has changed significantly. In the past, the standard case was that the business would be continued by the next generation. Family members were prepared for the takeover, and in practice there was no real alternative. Increasingly, we now see that the next generation has plans of its own. Or the business owner does not see the next generation as capable of filling such big shoes. That raises the question: What happens to the business? Can it be sold, or does it have to be liquidated?

Klassik Radio

In your view, what are the advantages of planning business succession early, as a strategic project?

Dr. Nikita Gontschar

If you plan early, you create options. If you address the issue years before retirement, you can make use of options you no longer have when, figuratively speaking, your back is against the wall. Or when the market turns and geopolitical upheavals make it impossible to transfer the business sensibly to an investor or a potential successor. These options take time: structuring tax matters, implementing a second management level. That does not happen overnight.

Klassik Radio

From when should companies specifically start dealing with their own succession?

Dr. Nikita Gontschar

In an ideal world, we realistically recommend seven to ten years to our clients. This is because there are tax holding periods and it is often necessary to implement a reorganisation of the corporate structure. That sounds like a long time at first. But structural changes, building a management level, finding suitable staff:
That takes time. Filling the role and getting up to speed does not take months; as a rule, it takes years.

Klassik Radio

We have just discussed why succession should not be left to chance, but should be a strategic project. Now we want to look at how to assess whether a business is even saleable. Dr. Gontschar, what should an entrepreneur keep in mind to ensure the business is saleable?

Dr. Nikita Gontschar

A business is saleable whenever it ideally functions even without the current owner. When there is a management level that works. When there are processes that work. When accounting and contracts are documented and the business is not run on verbal agreements and promises. When customer and supplier relationships are diversified. When it is stable and there is an expectation that a potential investor can generate returns from it in the future. Because the buyer is not buying the past; they are buying the future. And the future is only bright if the business actually generates profits.

Klassik Radio
What typical weak points do you often encounter when you look at a company’s saleability?

Dr. Nikita Gontschar

The classic issue in the SME sector is key-man risk, the one-man show. There is no second management level; the entrepreneur has all information exclusively in their head. Second: concentrations and cluster risks. Customers that are too large, that do not have long-term contracts, that leave or themselves run into financial difficulties. Suddenly
you can no longer rely on that cash flow. Then things take on a life of their own: banks cancel credit lines because the cash flow no longer fits. Added to that are new topics such as digitalisation, IT security and data protection, which were not on the radar because the business grew and the structures did not become more professional at the same pace
. These are the most common points we identify as part of a due diligence.

Klassik Radio
How do you recognise that a business is truly ready to be sold?

Dr. Nikita Gontschar

They are the same signals, framed positively. When the financial figures are reliable. When the cash flow is strong from a business perspective. When the company’s organisational structure is in good shape. The classic case is that the owner has run the business as if it would continue forever: property they bought privately, or an office bought privately and rented to the business. The private and business spheres are intertwined. This disentanglement, establishing stand-alone capability, takes time and first has to be identified at all. In addition, a certain continuity among employees and good internal communication are important:
building trust, communicating the story of the new generation in good time—not too early, but early enough—so that no one has to worry about their job.

Klassik Radio
We have talked about a company’s saleability. Now we want to take a closer look at the buyer’s perspective. Because acquiring companies instead of founding new ones is also a business model. Which buyer groups do you typically encounter in a business sale, Dr. Gontschar?

Dr. Nikita Gontschar

In the SME sector, there are typically four groups.

First, the strategic buyer. This can be a competitor or a company from an adjacent industry. They are considered as a buyer whenever they intend to realise synergies and consolidate functions.

Second, private equity investors—financial investors who want to improve and develop the business and then sell it on at a profit.

Third, the company’s own management, the so-called management buy-out. A very interesting group because management already knows the business, but often does not have the financing. That creates its own challenges.

And fourth, so-called search funds. These are individual, often younger entrepreneurs who want to become self-employed through an acquisition. Acquisition entrepreneurship. We have been seeing this more and more recently.

Klassik Radio
How does the perspective of a search-fund investor differ from that of a classic strategic buyer?

Dr. Nikita Gontschar

The strategic buyer wants to consolidate functions, minimise overhead costs and realise synergies. They may acquire an additional product portfolio to broaden their offering to customers. Whether that then requires duplicate HR, duplicate legal, duplicate sales departments, or whether it leads to rationalisation, is obvious.

The search-fund investor, by contrast, buys the business and wants to continue running it as a stand-alone operation, as it is, and then develop it further through so-called add-on acquisitions. The goal is for the business to continue in its identity and with its workforce. Continuity is the priority here.

Klassik Radio
What opportunities and what challenges can arise for entrepreneurs when they sell to such buyer types?

Dr. Nikita Gontschar

You always have to ask: Why is someone paying what purchase price, and what purchase price can a potential investor actually afford?

A strategic buyer who can calculate how many costs they will save in the future can afford a different purchase price than management, which may have earned very well over many years but cannot fund a purchase price from its own equity.

There are also differences in how the purchase price is paid: whether you receive a large part of the purchase price—or even the entire purchase price—immediately, whether there is a seller loan or other deferral elements, such as an earn-out. In other words, components that make the purchase price dependent on the company’s future success.

Klassik Radio
Dr. Gontschar, what role does the right timing play in the decision to sell a business?

Dr. Nikita Gontschar

Timing is crucial. Three levels come into play.

First, the macroeconomic environment. In times like these: interest rates, industry cycles, geopolitical issues and valuation levels in the M&A market. Are we in a buyer’s market or a seller’s market?

Second, the company’s development. Where does the business stand right now? Is it being sold at a time when the business is at its peak, or are the figures already at risk of turning?

And the third level is also crucial: the shareholder’s personal situation. How is their health? Can he or she continue to work for the business during a transition period? These are issues of decisive importance.

Klassik Radio
In your view, what criteria should an entrepreneur use to decide who they want to sell to?

Dr. Nikita Gontschar

The first point is obvious: the purchase price is of material importance for most sellers. However, we repeatedly observe that the purchase price alone is not decisive. When you are in a competitive process and several offers are on the table, you are tempted to give preference to the highest bidder. It is worth scrutinising the offer: Is the purchase price paid immediately or in tranches? Is it dependent on the company’s future development? And how certain is it that the purchase price will be paid at all? Is there already a financing confirmation?

For most entrepreneurs we advise and support, the fate of the employees is also very important. And also what happens to the business—whether the name is retained. Because most SME owners live in the same town, regularly drive past the premises after the sale, and are proud of their life’s work. Rightly so.

Klassik Radio
In your view, what should one definitely avoid when considering selling a business?

Dr. Nikita Gontschar

The biggest mistake is starting too late and addressing the issue too late. On a human level, I can understand why people put it off.

The second mistake: most businesses are running well and already have one or two offers on the table, without any structured buyer outreach having taken place. It would be a mistake to conduct bilateral discussions with this single offer, with this single interested buyer, without obtaining a market sentiment from other interested buyers. Approaching more interested buyers creates competition. You gain an additional perspective, you can compare. And as a seller, you are in a completely different negotiating position.