Passing The Bucks

Author:Hank Harris
Publish Date: Jul 22, 2019 02:21 PM EDT

19 08 08 07 08 12 original passing the bucks

Company founders and successors often dedicate their lives to building their businesses.  Having poured so much of their energies into developing a growing concern, you would think that virtually all owners of privately held businesses would have a detailed plan in place to provide for a continuity of the business.  Yet, those of us who consult in succession planning are often surprised at how often the subject is ignored, or no plan exists for the transition of a business' ownership and management.

Perhaps we should not be surprised.  After all, planning for succession is a task that lends itself almost perfectly to indefinite procrastination.  Consider that succession planning requires a business owner to:

  • Think about the business beyond their own participation in it;
  • Consider hard questions about who can and should own the business and run the business;
  • Distance themselves psychologically from the business as their primary source of identity; and,
  • Develop others to do the things they have always loved to do themselves.

For many owners, this short list and other related issues provide all the incentive necessary for them to think "I know I should do something on this, but it's difficult, so I'll do it next year."  And the years, of course, move along.

All businesses have a life span.  For the private business owner, the principal question is how long that span will be.  Is the business just there for me to make a living? Do I care if it continues? Should there be and can there be successive generations who take the business into the future?  How long will it take for me to come up with a plan and implement it? For an internal transition, we feel that the answer to this last question is about 10 years. Why 10 years?  Well, that is a good answer to a specific question, but that is typically about how long it takes to do two important things, which include:

  1. Having the original owners' capital extracted from the business and sufficient capital accumulated in the business for the new owners to run it; and,
  2. Sorting through and settling on the all-important people issues that make the plan successful.  New management will need to be evaluated, groomed, and tested over time. The best internal transitions are gradual, giving owners and successors time to deal with any challenges that arise.

Another relevant and universal truth for all businesses is that ultimately there are really only two choices for all of them at some point – they are either sold or they are liquidated.  Most business owners consider liquidation to be an anathema, and they should. After all, liquidation is a sad ending to someone's life's work and will yield the lowest possible value for the owners.  So setting liquidation aside, everything else is a form of selling the business. There are many options for selling, including selling to an outside third party, selling to employees, selling to family, selling to friends, gifting, and many variations on the theme.

For some owners, selling to a third party can make sense and might be their best plan.  An outside sale can be comparatively fast, gets the owners liquidity, infuses fresh capital, and fresh management.  However, for many (if not most) private companies, external sale is often less desirable than internal transition. Some reasons for this might include:

  • The business is not externally saleable.
  • The owner's after-tax realization from an external sale might actually be less than what they could realize from an internal transition over time.
  • Loss of control of the business is typically immediate and absolute.
  • Acquisitions are often viewed negatively by employees and may place some of them at risk.
  • Owner's "legacy interests" are less likely to survive third party acquisition. 

Therefore, many companies are best served with an internal plan.  But as referenced above, an internal plan takes effort and action.  Most plans have common issues to be addressed. Typical issues include:

  • Goals of the current owners in terms of financial payout, timetable, control, role in management, transition, or exit;
  • Potential successors to key management roles, what their needs are, and how they can develop;
  • How the business will be owned at some future point;
  • Whether owners in the future will be the people managing the business, or whether these issues are separated;
  • Equity transfer – the best mechanical means of moving the stock from one ownership group to the next;
  • Funding – internal transitions are usually internally funded.  Mechanics for making this work for current and new owners must be established;
  • Valuation – what is the best way to value the business for the transition;
  • Voting control and how and when it transitions;
  • Personal guarantees made by owners to outside entities, such as banks, sureties, or supplies; and,
  • Buy/sell shareholder agreements needed to accommodate the new structure.

While all this might seem daunting when viewed together, the most successful approach in our view is to approach this subject the same way that you approach most complex tasks.  Make a project out of it and work it accordingly. Involve your outside advisors (who will be needed in various steps along the way), get the right help to drive it to conclusion, and follow up implementation with periodic review.  An old saying is "nothing good comes easy." That probably applies to succession planning, but perpetuating your life's work is an important matter that makes the effort worthwhile.




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