Succession planning: importance of a comprehensive approach
As a business moves through its natural lifecycle and evolves, it faces many challenges along the way. The challenge of survival during the start-up phase is followed by the many challenges associated with growth. As a result, owners are usually dealing with the day-to-day requirements of running their business and overlook or defer succession planning “until tomorrow.”
Ignoring or repeatedly putting off this important task can eventually lead to an organization’s demise. Less than one third of businesses survive the transition from the first to the second generation — and even fewer make it past that. Planning and assembling the proper team is an important part of survival, success and sustainability.
The first step in succession planning is for the owners to recognize and accept that a succession plan is, in fact, needed. Not all businesses need a succession plan: Only those that have a long-term perspective with the desire to provide long-term employment opportunities to employees and meaningful value to their customers need apply.
Many people are uncomfortable discussing topics like aging, death and financial affairs, and these issues often become more difficult when considering the relationships and emotions tied to family dynamics. When succession is dealt with in urgent situations only, the results are often very poor. When the owners of a business can get to a point of acceptance — and have sufficient time, the development of a multi-faceted plan can begin.
Many succession plans focus on only one part of the transition; these plans are usually doomed to fail. A more comprehensive or holistic approach will greatly increase the odds of success. A comprehensive plan should address the financial issues, the management issues and the numerous non-financial issues of succession. Ownership succession, management succession and leadership development are critical. In addition, there may be a need to consider changing an organization’s business model due to technological improvements, industry innovations or the specific skill sets of the next generation.
Financial issues affect the business, the departing owners and the new owners. If the business is going to fund the buy-out of the former owners, an analysis needs to be performed to determine if the business will still be able to thrive, given its new repurchase obligations. These obligations can come from deferred compensation plans, ESOPs, redemptions and other mechanisms. If the plan handicaps the organization’s future capability for growth and strategic change, then it does not serve all of the needs of an effective plan. (Tax planning strategies will have a significant impact in this area, as well.) The plan also needs to meet the financial objectives of the selling shareholders. If the transition does not provide the needed cash flows to the departing owners, it will obviously not be feasible. Finally, the plan needs to be acceptable for the new owners. It cannot require the new owners to pay out cash flows to the former owners that are of an unreasonable amount or length of time.
The transition of management is also vital to the organization’s success. The new management team should be identified through careful analysis of individual capabilities. Simply plugging people in because they are family members or the “next in line” will often lead to a poorly managed business. Too often a second-generation family member inherits the reins when they do not have the capability (or drive) to effectively lead the organization into the future. Changes in management from one generation to the next can also cause dramatic shifts in the culture of the organization that can lead to negative outcomes. Again, identifying the target managers early will provide time to mentor and facilitate the transition. The successor managers require time for learning and time to recover from mistakes that may be made. If there are no mistakes made, there were no large chances taken.
There are also several non-financial issues that must be considered in succession planning. These are often most important to the founders of the organization. The business is usually an extension of the owners; their identities are tied to each other. After years of hard work and sacrifice to build their enterprise, the owners need to know that what they have built will not be destroyed. The owners may also have a familial relationship with their employees. Some employees will have been there a long time and will have helped build the business; the founders want to make sure these people are taken care of.
Another possible issue of concern relates specifically to businesses in which the owners have several children who may or may not be active in the business. Navigating the issues of fairness among siblings, while recognizing the considerable contributions of some over others, is often challenging. When this is added to the dynamics of estate and wealth planning on the part of the owners, additional issues may need to be taken into consideration.
Planning for the effective transition of a business is a process that often is neglected or addressed haphazardly. When this approach is taken, the results of one action may appear to address succession but cause significant problems in other areas. For this reason, it is best to work with a multi-disciplinary team of experts who recognize all of the key areas surrounding a good succession plan. They need to ask questions, learn about the business and its owners, and work with them to formulate a plan that meets the challenges of successfully transitioning to the next generation.
Eric Larson is the Partner-In-Charge of Beene Garter's Business Valuation Practice; Carol Hubbard is the Partner-In-Charge of the Audit Department.