The Keys to Unlocking a Successful Succession Plan
A Clear Vision, Thoughtful Leadership, and Flexibility
By Dick Blakeley and Doug Kennedy
Edited by Jared Friedman
Few financial concerns trouble transitioning business owners more than the succession planning phase of their careers. Such troubling concerns include:
- How do they seamlessly exit their business at retirement?
- How do they start a new business after smoothly exiting their old business (provided they are serial entrepreneurs)?
- How do they carefully pass their ownership interest to their children or to minority owners?
Recently, in our independent practices, we have had four conversations with successful business owners that have shed light on these concerns and revealed some valuable insights. Perhaps one of the most important insights is this: A steady, unemotional hand at the wheel guiding the succession planning process is critical. When circumstances change, as they quite often do, even the best laid plans require flexibility. With thoughtful leadership and professional guidance, owners have an excellent chance of crafting a win-win scenario for themselves and acquisition candidates, and successfully completing their exit strategy.
The first business owner we spoke with has spent 35 years building a business generating just over $15 million in annual revenue. He has been planning to exit the business for about 8 years and has a succession plan in place that is designed to increase the commitment and responsibilities of minority owners as the founder begins reducing his involvement. Alternatively, the industry he is in, is currently consolidating, and there are great acquisition candidates out there upon which his firm could capitalize. Nevertheless, the challenge for the minority owners is how to finance both the majority owner’s buyout while at the same time financing their acquisition --- the numbers just don’t work out to do both. Fortunately, the majority owner is practical enough to realize this and perceptive enough to know that his minority partners need to be positioned for growth in order to enable him to receive the payout he requires.
We’ve looked at a range of options for the majority owner, including strategies involving tax deferred compensation plans such as Employee Stock Option Plans (ESOPs), debt financing, hybrid securities (financial instruments that combine both debt and equity characteristics; i.e. convertible bonds, preferred stock, etc.), and even selling a minority position to an outside party willing to take and hold passively this minority position. Ultimately, we have come up with a negotiating strategy that the majority owner can utilize with his minority partners that we believe will meet his needs as well as theirs and will sustain the business. Such thoughtful leadership combined with the flexibility of the majority owner, will pave the way to a compromise that we believe will benefit all parties involved, producing a sustainable value for the business now and in the future.
The thoughtful leadership and flexibility of the majority owner is leading to a compromised solution to benefit all parties and achieve sustainable value for the business now and in the future. A more rigid thinking majority owner might have forced the minority owners into an untenable position and caused a disaster for the business risking his future payments/dividends. Note how thoughtful leadership is leading to a resolution that is realistic and beneficial to all parties.
Another recent conversation we had was with a 48 year old executive who wants to exit the business he owns when he is about 55. One thing we asked him to think carefully about was the high level of current comparable business valuations. There is no guarantee that 7 years from now, when he turns 55 years old, that the market will be as robust. As a result he is considering taking some chips off the table now by selling minority ownership positions to existing employees while developing internal talent to take over management.
An alternative option would be to sell a minority ownership position to a financially enabled party that has an interest in his industry. We’ve considered whether a sale to existing employees will better insure his ability to fund the buyout of his business in the future vs. having a financially stable third party take that position. Nonetheless, our business owner’s primary concern is not to disrupt his business nor diminish the commitment of his employees as the transition takes place. Their skills are in high demand and they can easily leave for lucrative jobs with competitors if they become dissatisfied. The third party option may be financially safer for the majority owner, but he has to balance his desire for financial stability with his desire to see some of his existing employees grow into professionals capable of leading the business in future.
A third business owner with whom we discussed succession planning recently made this observation. “When I started my business 9 years ago I wanted to exit in 5 years. Unfortunately, year 4 of my startup was 2008 when the economy was in a deep recession and business valuations were dreadfully low.” Exiting as he had planned in 2009 at anything resembling a reasonable price was impossible. Fortunately he was able to survive the recession and is now, finally in position to exit at a reasonable value. As he said “I knew my plan had a downside risk to it and the worst case scenario did take place. When the recession struck I had to rethink what my financial needs were, how I was going to leave the business I was selling in good enough shape to survive a change in ownership, and what assets I could place into my retirement plan vs. those I was going to put into my next venture.”
Our fourth conversation was with a pair of business owners whose goal was to sell their service and manufacturing company to a much larger firm in the service industry. Their dream was to use the proceeds from the sale of their company to move to a rural area and let go of the rigors and stresses that come with owning a business. As we were helping them with this assignment, it became clear that the purchasing company had no intention of paying for, or managing the manufacturing arm of the company. We helped the owners reorganize the division and spin it off to themselves as a new company, and sell a minority interest of the new company to their son who manages the "stub" of the old company. They sold the service side of the company for the same amount they would have sold the entire company to the original purchasing firm. Their son has successfully managed the manufacturing side of the business for the past five years, and now that the five year non-compete provision has expired, the son is discussing with his parent and his advisory board the opportunity of re-entering the service side of the business. Dad and Mom are supportive of their son's proposal and he is looking to grow the company again to its past success.
All things considered, the conversations we’ve had with these four business owners have illustrated some fundamental yet critical points. Foremost, succession planning is not something to be left to chance. It is imperative to put a written plan together, as it will crystallize your thinking and point out areas of highest risk. Once identified, these risks form the blueprint from which to begin the process of designing a favorable succession plan --- one that will help mitigate the effects of these risks and substantially increase the likelihood of seamlessly exiting your business. In every plan, regardless of the age of the business owner, or the size of the business, there are complex financial choices to be made and alternatives to be considered. Remember, a clear eyed vision of what you want to achieve and the flexibility to accommodate a changing business environment is required to navigate the economic and competitive situations that may arise as you face succession.
Dick Blakeley is founder and CEO of The Blakeley Group, Inc., an Investment Advisory firm in Santa Clara, California. The Blakeley Group serves a broad client base from young high tech entrepreneurs requiring wealth building expertise to retiring professionals who need guidance and support through the complex retirement process. Dick has been in the financial services industry for over 30 years.
Doug Kennedy is a partner at CFOs2GO, a boutique financial consultancy and recruiting firm based in Walnut Creek, CA. Doug has over 30 years of financial services experience advising family owned businesses and business owners from start-ups to mature enterprises on a range of business issues.