Succession – Not the TV Series!

Author:Hank Harris
Publish Date: Feb 25, 2020 05:42 PM EDT

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Management consultants tend to labor in obscurity. Having been one for over 35 years, that always suited me just fine. Our issues, after all, focus exclusively on the business world and are typically not much engaged by "pop culture." So, it has been a real kick to see one of the issues I have dealt with my entire career – management succession – suddenly elevated to the theme of a popular television series.

The show "Succession" features a fictional mogul facing his older years and his younger offspring, family, and employees striving to fill his shoes. Everyone schemes and behaves poorly and it all really makes for great entertainment. The fact that a routine business issue finds itself current television highlights what a big deal this issue is right now in the market. Largely this is a function of simple demographics. There is a massive number of baby boomers with private business interests who now find themselves on the "back 9" of the game of life.

Despite all this newfound attention, it still seems that the succession subject is an anathema to many business owners. After all, dealing with what happens when you are no longer at the helm is not as much fun as dealing with the here and now. Most business principals seem to fit in one of three groups on the subject:

  1. "I refuse to even think about it." One of my clients said to me he did not understand why he should care if he was not going to be around!
  2. "I know I should do something, but now is not a good time." This, of course, is mere procrastination. There is never a good time.
  3. "It will take effort, but it's in my enlightened self-interest." This is true, and it is also in the interest of family and employees. Often, this is a critical process to sustaining an owner's legacy.

So, what motivates a business owner to join group 3 and actually work on a plan? Legacy can be a big motivator. Working to build a business for most of your adult life, and then allowing a lack of planning to compromise its continuity, is a real shame. In broad terms, there are really only two outcomes for a business that moves beyond its founding generation: the business is either liquidated or it is sold. Liquidation is not attractive for many reasons, not the least of which is minimum value realization. Everything else is a form of sale – selling to outsiders, employees, family, etc.

In today's world, many owners have more exit options than they used to. More companies are in the market to grow by buying other companies, alternative buyers and interests like private equity and investment funds are now significant, and ESOPs are much more common. Despite all of these options and their many advantages for some owners, they will not be a good fit for the vast majority of privately held businesses. Which means that most private businesses are better served with an internal transition plan. This is especially true if you have a potential next generation of management (family, employees, or a combination of them), you would like to stay involved with business indefinitely, keep control, and design your own process.

If you decide that an internal transition plan is your best direction, there are a few "myths" associated with them that are worth noting:

Myth #1 – "Valuation of the equity and obtaining a fair market value from my insiders is critical." In most cases, this is unlikely, since your insiders probably have no money and this direction will not work for you unless you help them buy equity over time.

Myth #2 – "An easy option is just to let my business flow into my estate." That might make sense if your business is not high risk, volatile, or otherwise lends itself to passive ownership. However, many privately held businesses do not do well when owned by family members who do not well understand what they have inherited.

Myth #3 – "I can readily get this done with my lawyer and accountant."  This is true for some business owners, but probably a minority. Most owners tend to develop scenarios over time where multiple personalities, objectives, and agendas are involved. Often, professional help in understanding and synthesizing all of these into clear objectives and concrete plans is beneficial. In fact, the tax, legal, and financial mechanics really cannot proceed without knowing the end game.

Myth #4 – "I will come up with something when I'm ready to exit." You might come up with something, but it will not be an internal transition. The typical transition to insiders takes 10 years to implement. There are two reasons for this, the first of which is just math. Owners from Generation A are going to start to extract a certain amount of capital from the business; and owners from Generation B have no realistic source of earnings with which to purchase the business, other than the business itself. All the while, the business needs to continue to run well and at a certain level of capitalization. Making this work financially is a 10 year process, give or take. The second reason transitions take this kind of time is that people issues do not work out exactly as planned – most of the time – and the next generation leaders have to evolve from being "worker bees" to top management. The original owners often dismiss, or grossly underestimate, what it takes to prepare the next generation to lead.

Despite these myths and other issues, internal transitional can still be a very attractive option for some owners. Selling the business to an outsider (if it can be sold), does offer a fast exit at an immediately higher valuation. But, most owners hate working for someone else and they're usually gone soon after the deal closes. Also, after the "monetizing event" occurs, you're done. Most of the private businesses I worked with sold externally for 4 to 6 times pretax earnings. With an internal transition, you might share earnings and sell at a discount, but you can stay (and keep control) indefinitely.

If you do decide that internal transition is your best fit, there will be issues unique to your situation and your people that require planning. There are also many common issues that should be addressed in your plan. Some of them include:

  • How the business will be owned in the next 5 years and 10 years.
  • How the business will be lead and managed over that same time horizon.
  • What the best mechanics of equity transfer will be, in light of tax, valuation, and financial objectives.
  • What contingency plans should exist in the event of unexpected death, disability, or removal of a key owner.
  • Creation or revision of shareholder agreements.
  • Specific actions for developing management expertise within the next generation.
  • How the transition plan is monitored and implemented.

Thinking through all of this and getting a plan in effect does take some effort. But, most owners are only going to do this once and often their life's work and legacy is at stake. From that perspective, the effort would seem to be well worthwhile.




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