Business Succession Planning 2020— Case in Point: German Mittelstand
Mittelstand firms struggle with generational change: What’s at stake for the German economy? How can craftsmen hand over their business successfully?
In Germany, the successful management of business transferal is becoming a growing challenge for the SME sector (“German Mittelstand”). By 2020, 236,000 owners will withdraw from their business and place operation into the hands of a successor. This applies to 6% of all SMEs in Germany by the end of 2019. An addtional 7% of the SMEs plans their succession in between 2020 and 2022. In total, 511,000 sucessions must take place by 2022¹ (see Exhibit 1).
According to a study by the ZDH (German Confederation of Skilled Crafts and Small Businesses), the craftsmen’s & industrial supplies sector will be hit particularly hard. The sector consists of ca. 1m SMEs with 5.5m employees; 180,000 of those companies will be looking for a succession plan by 2020². The ZDH’s résumé is unambigous:
“Without proper succession planning, the craftsmen’s sector will experience a loss in know-how and value created; and its role as an attractive employer for the youth is at stake.”
What’s at stake for the German economy?
Unclear succession is an enormous barrier to investment for the German economy. Why is this so? The issue is twofold: (1) The imminent transfer of ownership, coupled with (2) the owner-manager’s generally high age reduces their propensity to invest.
First, the nearer the time to transfer ownership and control approaches, the less owners are willing to invest. If the succession is planned within the next 5 years, the willingness to invest is at 41%. However, If the planned succession is >5 years in the future, the willingness to invest increases to 56%. SMEs scheduled for imminent succession (within 2 years) have a lower investment intensity (€ 5,700 per FTE) than those whose successions is far in the future (11 to 20 years) who invest € 7,900. Owners planning to discontinue the business hardly invest at all (30%).
Second, many mature-aged business owners believe investments have a long payback period. 1.4 million of the owners aged 55 or over. One quarter of them will be aged >70 by the time they retire — 1 in 10 will be aged 80. Having reached a high age, they avoid long-term financial commitments.
How does the Mittelstand prepare for the business succession? What are the options available?
About 62% of SMEs surveyed by the ZDH are not prepared at all for generational change ahead. More than 50% did not decide on the type of succession yet. This is an alarming insight as thorough planning is THE #1 success factor for business succession.
Family succession is the most popular option. 54% of owners want to leave their business in the hands of a family member when they retire. 42% can imagine selling their business to an external buyer. Fewer SME owners consider handing over to an existing employee (25%) or co-owner (27%).
Exhibit 2 highlights the fact that succesion plans differ across industries: Over 30% of SMEs in retail, construction and the services sector plan cessation of their businesses. By contrast, in manufacturing more than 75% of the owners definitely want a successor to take over.
The face of the German Mittelstand will definitely change in the next decade due to planned closures. For 1 in 7 owners (14% or 545,000 SMEs), shutting down is currently the only option under consideration. Larger SMEs (50+ employees) favour succession but only half of micro-enterprises (<5 employees) do. They are 8x more likely to close down.
Either way, the inter-personal implications are not to be understated as Jörg Zeuner, head economist at KfW, concludes. Finding an outside management team or founder is a considerable challenge. Selling the firm also tends to lead to disappointment. Many older owners’ valuation expectations are too high. However, flipping the family heirloom at bargain prices can be traumatic. If family entrepreneurs sell their company, they are often so emotionally attached that “passing it on to a stranger feels like a funeral.” Choosing employees who take the helm also tends to lead to misery. According to consultant Christoph Reiter, here it is “less about the purchase price, but for the retiring boss to come to terms with switching from a ‘senior role’ to a ‘junior one’”.³
Successful succession planning does not gurantee, but it is a mere prerequisite for value-creating operations for the next generations. A study by Deloitte outlines the difficult odds, your business faces:
In the case of family-owned businesses, only 30% survive into the second generation, 12% survive into the third, and only about 3% operate into the fourth generation and beyond.⁴
How to take action: A Checklist for Succession Plan
Since KFW’s research suggests that preparation and timeliness are key to avoid ongoing negotiations that detract from running operations and stifle investments, business must take action early on. Initial uncertainty may be high but once succession is clarified, investments increase again by 40%, which is vital for the German economy. Exhibit 3 is a step-by-step guide on what YOU should consider when handing over YOUR business⁵:
Have you had any experiences in handing over a business? Leave a comment below.
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