“You’ve got to be careful if you don’t know where you’re going, because you might get there.”
Every business, new and old, needs to know where it’s going. Businesses can pivot all they want, but they still need to deal with succession. How can an entrepreneur or other person pass on his or her business or at the very least realize the value in the business?
It’s a classic problem. An entrepreneur works his or her whole life building a business. It’s very difficult for the entrepreneur to realize that it’s time to start transitioning the business, to support others in the running and further building of the business.
An owner who has failed to consider succession planning has not just failed him or herself or the business—the owner has also failed his family and his employees and his customers.
What is Succession Planning?
Succession planning can take many different forms. But there are basically four different options. The first is an internal succession plan with partners or key professional employees. The second is a merger with another firm. The third is the bringing in on a new employee or partner for an eventual buy-out. And the fourth, the least desirable, is the winding down of the business.
If Not Now, When?
Succession planning should start as soon as possible after the company is formed. This is especially true when the succession will be a plan between partners or professional employees. It’s at the onset of an organization’s life that the parties are most happy with each other, and can more easily form an agreement about what to do when they no longer want—or no longer can—work together.
So why do people wait to plan for succession? The usual reason is that they are too busy, that they have more important things to do.
This isn’t particularly convincing. If an owner wants to take care of his family, employees and customers after he is gone, and if he wants to realize value from his business, he needs to plan ahead.
And this means more than just writing and signing a will.
I don’t want to diminish the value of having a will. But wills and estate planning are limited in their scope – it’s planning to minimize estate taxes and take care of family members. A proper succession plan can be much more—it can certainly be used to take care of family members, but it can also be used to take care of customers, used to pick and prepare successors and used to set up a framework for dispute resolution.
I had a client—basically a one-man shop—with revenue in the eight figures. Like many of us, he felt he was immortal (or at least acted that way). He had a short-term business continuity plan. He also thought he was taking care of his family by signing a will and creating various trusts for his family’s benefit. What he failed to do was truly consider what would happen upon his death.
Sure enough, quite unexpectedly, but not surprisingly, this client died. Under the terms of his will, his wife became the owner of his business. But she knew nothing about the business, and neither did anyone else in the family. There was no one who could successfully take on the job.
Fortunately, we were able to work with the family and find another company that was willing to take over the business. But it was touch and go and customers were left adrift. And the amount of money that the family realized from the business was a fraction of what it could have been with proper planning.
Think about succession planning sooner rather than later.
Death and disability are almost always a surprise. And there are real benefits to taking care of succession planning and taking care of it now. There will be clear continuity for customers and vendors; the new leader will have time to learn from the old leader; the old leader can be confident that the business he has built will continue to be run successfully, that he will have a comfortable retirement, and that his family will be provided for; and everyone will have time to adjust to the change in leadership.
For many business owners, an internal succession plan is the best approach. A tried-and-true method of handling such a plan is with a buy-sell arrangement between principals of the firm.
Since more and more companies are being organized as limited liability companies, it makes sense to consider the issues within the framework of an LLC. The operating agreement is the basic organizational document for the LLC. It’s the best place to provide for a buy-sell arrangement.
The agreement can provide for the sale of an owner’s interest in the LLC upon his death or disability. The sale can be supported by “key person” life and disability insurance.
Probably, the easiest way to explain is by giving an example.
George and Martha are co-owners of WashCo, LLC. George takes out a life insurance policy on Martha; Martha does the same for George. Now, if George happens to die, Martha collects on the insurance policy on his life and uses the proceeds to purchase George’s share of the business.
The real nice thing about this arrangement is that George’s basis in the business is stepped up to fair market value when he dies. Martha gets this stepped up basis.
This can also be done with partners and key employees. And anytime in the life of the organization. It is, though, far easier to do at the onset.
There are plenty of other options for co-owner buy-outs. One of these is the bullet buy-sell, sometimes known as the boomerang or Russian Roulette.
In Russian Roulette, one of the co-owners will offer to buy the interest of another owner. That owner may accept the offer or turn it around and acquire the interest of the offering owner upon the same terms and conditions as the original owner. Another variant of this is with puts instead of calls.
Mergers and Acquisitions
Another significant option for a mature advisory firm is to merge with, or acquire, another firm.
The key, of course, is finding the right merger or acquisition partner. Probably, the best choices for merger partners are local competitors or companies in similar businesses in different regions. This is not to say that a partner in a different business is necessarily bad. However, such a partner may not be able to successful function in all areas of the combined business. Mergers and acquisitions tend to take longer and cost more than internal succession plans.
Depending on how the merger is structured, the merger or acquisition may, or may not, need regulatory approval.
Another option is to bring in an outsider and train him or her to take over. This may be the best approach if there aren’t any internal successors and a merger or acquisition candidate can’t be found.
Of course, there is a risk that this person will learn the business and then just leave.
That’s why I generally recommend that new personnel—whether brought on as employees, consultants or equity holders—sign nondisclosure and nonsolicitation agreements. These agreements are far from full-proof, but they certainly make it much more difficult for a person to leave a business with the fruits of its owner’s labor.
Entrepreneurs and other business owners owe a duty to themselves and their families, their employees and customers to ensure that the success of their businesses continues after their retirement or death. Succession planning should be considered at the earliest opportunity.
“If you don’t know where you are going, you’ll end up someplace else.”
—Alan N. Walter