Succession planning is a process for business owners to determine exactly how a business can continue after its founders (or current owners) leave through either sale of the business, retirement, disability or death. It involves every aspect of the business and personal lives of the current owners and proposed future owners.
The typical end result of succession planning is the identification of an exit strategy for current owners that satisfies their ongoing needs and a plan for the identification and implementation of the structure necessary for the business to survive and thrive independently of its current owners.
Oftentimes, business owners do not consider that at some point, they will no longer be an owner of the business. Whether their exit is the result of a planned or unplanned departure and what happens to their business and their family before, during and after that departure can and should be positively affected by what they do today through the creation and implementation of an appropriate succession plan.
Though every plan and strategy will vary based on the objectives of each owner and each business, all succession plans have two common aspects: a plan for the transition of ownership; and a plan for the transition of management and control. The second aspect is both the most difficult and most important.
Possible Exit Strategies Available to Business Owners
1. A liquidation of the business: always an option, but this option is not likely to produce the highest value to the owner;
2. The sale of the business to “insiders” (other shareholders or employees): a possibility, however, in many cases, no other shareholder or employee will have funds to provide the “cash out” price except through the use of the assets and business operations of the business (which can create a problem of adequate financial security for the owner);
3. The sale of the business to “outsiders” (strategic buyer, financial buyer, foreign buyer): a possibility, but there is potential downside if the market learns that the business is “for sale;”
4. Creation of a “benevolent dictatorship” (leave it to the kids): a possibility, but the children may not know the business, and children typically will not have the funds to provide the “cash out” price except through the assets and business operations of the business;
5. A joint venture or merger: a possibility if it can be structured to provide results similar to “sale of business” to outsider; and
6. An initial public offering (IPO): only possible for a small minority of closely held business clients due to the complex issues involved.
The selection of an exit strategy and exit planning should commence no later than five years prior to the desired departure of the owner.
Consensus on a succession plan is best obtained when there is an atmosphere that permits sharing of information (especially financial data) and a clear willingness to seek and give input before major decisions are made.
Key Elements of the Succession Planning Process
The succession planning process is a complicated one which involves consideration of the following elements:
• the business’s strategic plan,
• the business’s current financial condition and cash flow,
• the corporate finance and options available,
• relationships among the owners and their families,
• stakeholders’ interests (current owners, potential successors, management and key employees),
• leadership abilities of potential successors,
• planning already in place (estate planning, life insurance planning, retirement planning, investment and funding mechanism planning, and business valuation),
• planning for the disability or death of the owners,
• organizational and entity structure as related tax effects,
• executive compensation planning (current and deferred),
• equity and non-equity incentive arrangements,
• owner’s agreements (buy-sell, cross-purchase, redemption, etc.), and
• the negotiation and mediation skills necessary in order to create and implement a succession plan which satisfies the interest of all stakeholders.
In next month’s article, we will discuss a Five Step Process for helping business owners create the optimum succession plan for their businesses which best meets the business and personal objectives of current and future owners and also leads to maximizing the value of the business.