Succession planning creating a dynasty

July 30, 2012
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Recently, I spent time with old friends reminiscing about the "glory days" of high school athletics. We were lucky to be part of some excellent sports teams in our youth, teams that continue to perform well year after year. That longevity of success transcends the talent of individual players; it reflects a strong culture, good communication and thoughtful planning for the inevitable transitions that occur in players and coaches over time.

While just as committed to building lasting success in their family business, many business owners cringe at the thought of succession planning. They tend to think about the energy, emotion and expense of the process and instead prefer to focus on the current "season." Yet without adequate planning for a smooth transition, an unforeseen life-changing event or two can seriously derail the business.

Whether the transition of your business is years or months away, you can start the planning process now by considering how you would approach the following initiatives:

Communicate your plan. Many leaders of successful family businesses regularly communicate their thoughts about succession to their outside advisors. One owner I work with sits down with me, his accountant and his wealth advisor every year to consider the tax, cash flow and practical effects of alternative exit strategies. As a team, we understand his wishes and intent and are completely prepared to support his successors. Consider setting up a meeting with your team of advisors this year and include them in your succession planning efforts. This enhanced level of communication will help stimulate an effective transition process down the road. 

Engage future leaders. Ask the next generation to share their visions for the future of the business. Encourage them to solve or be a part of the problem-solving team for some of the business's most important issues. There is no better way for young teammates to learn, and the next gen often has valuable insights to offer. At a recent industry event, a client who previously brought his nephew into the ownership group proudly told me he led the effort to consolidate front office functions across their business lines, resulting in an immediate and lasting benefit to the company's bottom line. Take the time to challenge the young leaders in your company to grow outside their comfort zone.

Lost talent. Believe it or not, we won't live forever. Death is often sudden and has the effect of leaving the business and the decedent's heirs financially unprotected. Without an effective succession plan, surviving owners will be challenged financially and emotionally. This happened last year to an automotive supplier when one of its owners and top sales managers died in a small plane crash. That once extremely successful, 25-employee business is still struggling to generate cash flow today. Review your current succession plan and buy-sell agreement if you have one. Work with your advisors to modify these documents in the event that they do not reflect your intent.

Divided talent. Nearly half of all marriages end in divorce. Divorce by a business owner from their spouse can cause a business to crumble. It is not uncommon for a judge to award an interest in a business to a former spouse if other marital assets are unavailable. There are ways to protect against this ahead of time and you should review your buy-sell agreement to determine whether it contains provisions related to divorce. One way to protect the business is to include language in your buy-sell agreement giving the company a right to redeem the divorced owner's interests for a pre-determined discounted amount in the event a court awards that interest to the spouse. 

Impaired talent. The risk of becoming disabled during one's career is significant, and owners should think about how to replace or substitute the talent of a co-owner that could be lost ahead of time. For long-term disabilities, the best course of action may be to buy out that individual's interest once it is evident that they will not be able to return. Be sure to adequately define what it means to be "disabled" in your operating agreement or bylaws and identify the individual(s) who will make the final determination of such disability. Taking these steps will prevent disagreements in the future.

Valuation methodology. I often hear disagreements between business owners about the "correct" method to value a business and disputes over the "proper" method that the appraiser did or did not use. Recently, I worked with a client where there was a 45 percent difference in value depending on which method was used, even though each method had credible support. Identifying an agreed-upon valuation method ahead of time will prevent such squabbles and save the business unnecessary expense. Talk with your advisors about the different methods of valuation and which one might be appropriate for your business.

Fresh start. Have you ever been frustrated with your management team? Sure you have. Maybe your VP of operations (who happens to be your son) periodically walks a different path than where you want the business to go, and you haven't looked through their glasses or vice-versa. Maybe both paths are wrong. In any event, communication will help sort through the unknown. If you anticipate a difficult conversation, consider working with a professional facilitator familiar with family business dynamics. For reference, the Family Business Institute offers conflict resolutions services. See http://bit.ly/familyconflict

Taxes. It's no secret that some businesses are starting to climb out of the recent recession, and retirement portfolios are beginning to rebound. This year may provide the last great opportunity to transfer ownership by sale or by gift to the next generation due to the potential tax ramifications of waiting until 2013. We have had success with clients making such transfers while still retaining control over the business. Talk with your advisors about these planning opportunities.

I often hear from business owners that they are too involved to plan for succession, too tired to find the best talent and too busy to communicate risks and opportunities with the next leaders of their business until succession is imminent. I get that. Taking the innovators away from innovating may not be the best use of their time.

That said, I encourage you to hit the "pause" button once in a while to look forward to next season before it starts. A little planning time invested now, with your advisors, will provide a strong return on the future of your business.

Scott J. Hill is a transactional and succession planning attorney in the law firm of Varnum LLP.

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