If 2020 has demonstrated one thing above all else, it is that we can never take things for granted.
Life can be unpredictable, and this means circumstances beyond our control – be it a personal matter like a death or divorce, or a worldwide incident like the COVID-19 outbreak – can dictate the future for individuals, families and businesses.
While it is impossible to predict the future, it is possible to prepare for it, which is where effective succession planning can reap rewards for business owners. In turbulent times such as this, the value of having a structured plan for life can help cut away the chaos and offer an advantageous layer of security.
Yet, research conducted by Wilmington Trust in 2017 revealed that 58% of business owners did not have a specified succession plan for their organization.
I hope that recent events have resulted in this percentage declining, but it demonstrates that many are risking the continued legacy of their business and the value of their exit by not preparing for the inevitability that they won’t be in charge forever.
With this in mind, I’d like to use this article to discuss the importance of succession planning, outline the unhelpful assumptions that some make regarding the future of their company, and what a well-thought-out plan should incorporate.
What is succession planning?
At its most fundamental level, succession planning outlines the necessary actions to ensure a business will continue when the owner is no longer involved in the day-to-day operations. But, in addition, it also can play a key role in protecting the equity owners have built into their business, and consequently maximize the return they receive for their years of hard work and investment in the organization.
It is a roadmap for your business beyond your guidance. As the team and I at Generational Equity have noted time and again, owner dependence can be a major red flag for prospective buyers or investors – the closer you are tied to the success of your business, the more concerned buyers will be about its prospects without you at the helm:
- Are you primarily responsible for your relationships with clients or suppliers?
- Have you dedicated time to building and training your management team?
- Do you delegate key decisions?
- Are your business processes documented and shared, or locked in your mind?
Among the core components of any successful succession plan are factors such as:
- Hiring and developing an effective middle management team
- Building decision-making processes that extend beyond the owner
- Creating a client relations team
- Constructing a long-term strategic plan for the business
These are among the core steps that you can take while still at the reins of your company to best prepare it for when you let go. Not only will this support long-term business continuity, but it will also indicate to potential buyers that your company is sustainable and can still thrive in your absence.
Where do people often go wrong with succession planning?
When I consider the issues that many business owners have surrounding succession planning, one word always comes to mind: assumptions. More precisely, it is owners assuming that one of these two scenarios will take place:
- The business will be taken over by their son, their daughter or another family member
- The business will be acquired by one of their employees
While I am not suggesting that in certain circumstances these aren’t appropriate or workable, making the assumption without some serious conversations or considerations can have disastrous consequences.
First, let’s consider passing on the business to your offspring. Rather than making the bold assumption that they would like to run the business when you’re ready to depart, have a conversation with them about this idea.
They may have aspirations in another business or industry altogether, and if they don’t have the desire to run your company, or only do so out of obligation rather than choice, this can put the future prospects of the business you’ve spent years developing in jeopardy.
Furthermore, you have to consider objectively if any of your family members have the necessary attributes to run a company. It’s one thing to take on a middle management position in the business to gain experience – actually managing an organization is an entirely different animal.
Not to mention the insult that key employees could feel if you hand the company over to your child, particularly if they had no connection to the business beforehand.
And what about financing the transaction? Most likely you will be required to provide a long term note on the business, requiring your offspring to reach key financial metrics, post-acquisition in order to buy you out over 3-5 years (or more). Do your kids have the ability to meet these financial requirements and do you have the faith that they can?
So, what about the prospect of selling to your employees? On the surface, this appears preferable – if you have trained a strong middle management team that understands your company inside-and-out, assigning one of them as your successor can support a seamless transition within the company.
However, this benefit can be outweighed by the financial burden this imposes on the departing owner. Most key employees won’t have the same buying power as a professional buyer or a private equity firm has available.
This means that you will either be selling your company for less than what it’s worth, which shouldn’t be considered based on the blood, sweat and tears you’ve poured into the company, or you will have to carry paper financing the deal over a 3-5-year period (or longer). This is risky because, if the business falters outside of your management, does this affect the value of your buyout?
Of course this is the same issue you face if you sell the business to family members: Is the capital available to cash you out or will you be on the hook for a long term loan where you have no control over the success of the business?
What should a well-executed succession plan include?
So, what steps should you take to develop a successful succession plan?
Most importantly, determine your personal financial needs going forward. You need to meet with your wealth management team and determine how much you need for the next phase of your life. If you are financially able to provide financing to your family members/key employees for a 3-5 year time frame, then great, closely examine those two options.
However, if you are not, then the best plan is to look for buyers outside of your family and internal team. As tough as that may be to face, we have found that in most situations, a professional external buyer, with the resources to both cash you out AND provide for the ongoing growth of the company (and your legacy) is really a far better option for you and your company, family, and associates.
Start now to secure your financial legacy
Hopefully this has given you a launching pad to think about the importance of succession planning with your business. As 2020 has demonstrated all too clearly, your company is too meaningful and valuable to leave its future up to chance, or at the mercy of circumstances beyond your control.
The key now is to start planning if you haven’t already – the earlier you can begin cementing the facets of your eventual departure and what comes next, whether you plan to exit next year or in the next decade, the more you will benefit in the long-run.
This is why I recommend that business owners who have no exit plans in place, attend a Generational growth and exit planning conference. We have designed these to provide valuable information to business owners about the key components of a successful exit and how to do so in a way that maximizes the return to you.
Until next time, I wish you nothing but the best for the months ahead as we continue to contend with these challenging times.