When asked the significance of a company succession plan, experts were united when they explained the absolute necessity of a good plan.
“[Succession planning] may be the most important thing for a business and it is for sure the thing that is done less well,” said Carl Rowe, founder and senior consultant of Clarity Advisors to Management, which provides solutions to struggling companies.
“It’s crucial,” concurred Brooke Borg, founder, and attorney, Borg Law Group in Las Vegas, who practices in the areas of estate planning and probate and business law.
“It is irresponsible to not have a written succession plan,” said Gian Brown, the attorney with Holland & Hart in Las Vegas, who specializes in corporate transactions. “Irresponsible to your co-owners, your employees, your family, your customers and your vendors.”
A succession plan is a well-thought-out, documented strategy for how an operation of an enterprise will transition and continue with competent, future leadership should an owner or key executive becomes unable to perform their duties due to retirement, disability or death.
According to Brown, some of the questions a good plan answers are:
- If something happens to me or a key executive when I or they want to retire, how will the business go on?
- How do I protect myself as the owner?
- What will happen to my family?
- Who will take my place?
- Who will take the executive’s place?
- How will the replacement get trained to take over?
- If something happens to one of my partners, what does the future of the operation look like?
A business succession plan isn’t only necessary for the owner of a company, but also, “for all of your key positions, the whole C suite, if you will,” Rowe said. He noted it’s referred to as management development. “You don’t want to get caught losing a key person,” Rowe added.
There’s tremendous value in having those details worked out and formalized.
“Once you have [a succession plan] in place, it’s peace of mind because you know that your business can continue on successfully,” Borg said. “If it’s in writing and the parties follow the plan, then usually, it works without a hitch.”
Bleak Situations to Avoid
The consequences of not having a succession plan can be dire if, for example, something drastic and unexpected suddenly impacts an owner or executive. In one of the most common, worst cases, the company “ceases to exist,” Rowe said.
Borg has also seen that scenario play out numerous times. “We have horror story after horror story of clients who didn’t have a succession plan in place and the unthinkable happens and the business they’ve worked years to build fails,” explained Borg. “Nobody knows who’s going to step up or should step up or there’s fighting between key employees, the heirs to the business or the owners and they can’t make it work.”
Having no succession plan could lead to lawsuits being filed against the company because, perhaps, it no longer is meeting its obligations in the manner expected or at all, Brown said. This could happen despite the best intentions and efforts of the remaining staff in trying to keep the operation afloat.
Oftentimes, “protracted chaos and uncertainty” ensue, Brown added. Employees, management, customers, and vendors are thrown into limbo with no clear way out. In such a situation, details can get overlooked.
“More importantly, it makes for a situation that is ripe for exploitation by people who have agendas,” said Brown. “It is handing the keys to your competitors.”
Tough Issues to Tackle
“Only a small number of companies do succession planning,” Rowe said, despite the gravity of the reasons for doing so and the bleakness of the outcomes when not having done one.
A major reason is that developing such a strategy can be daunting and difficult, particularly when it comes to the emotional aspects.
“It’s all about emotion, legacy, and big scary existential issues, Brown said. “It’s the sticky stuff, the human stuff” that can bog down the process.
Those difficult parts include facing and contemplating one’s mortality, having frank discussions with employees and family members and dealing with family expectations, dynamics and baggage. People, oftentimes, don’t want to think about those issues and/or don’t want to discuss their feelings and desires. In addition, they’re busy running their company.
Others may not fully understand they need a succession plan, what it protects against, what it looks like or how to go about creating one, Borg said. They may have misguided ideas about it. For instance, they may think their business will go automatically to their heirs upon their retirement or their death. However, that might not be best for the enterprise, as they may not want it, or may not be suited to run it.
The Timing Elements
Ideally, a succession plan should be created soon after starting a business, Brown said, so it’s ready when it’s needed. In fact, startups seeking financing and companies that bid for government contracts must prove they have such a strategy in place because investors and contracting entities want to be assured an operation can survive and thrive if a key member of the organization can’t perform their role anymore.
Further, once a succession plan starts to be carried out, the process takes times. For example, if the strategy is to sell the business, the owner is at the mercy and timing of the market.
“The biggest mistake is, they don’t start early enough,” Rowe said.
Once a succession plan and its components are in writing, Borg said, it should be revisited and updated, ideally, every year but at least every two years to reflect any changes—to the business’ valuation, to key employees and the like—that may have occurred in the interim.
If the owner or CEO wants to retire but lacks a succession plan, it could take years to effect their exit because no one had been previously working toward it, Rowe said. People tend to be unrealistic about the time requirements.
“The average time period to exit is ideally three years to really do the kind of analytical work necessary and to begin to groom people because, remember, we’re looking at the C suite,” Rowe added. “But even in a small company, to hunt for and develop the skills necessary to run the business takes a while. Give yourself as much time as you possibly can.”
Therefore, owners and executives without a plan who may be thinking about retirement should begin work on their succession strategy immediately.
Typically, a business will first address a succession plan when a key person wants to retire, which shouldn’t be the case, Borg said. Oftentimes, it’ll come up when they’re working on estate planning and preparing their will and trust. If it doesn’t, it should.
Today, having a succession plan is even more critical due to a major demographic trend.
“We’re seeing a tidal wave of retirements among baby boomers,” Rowe said. “There’s a huge need for this kind of planning. It’s not happening. That’s a major problem now for lots of businesses, which is why it’s so important for a business owner to be doing this now.”
Succession Options
Several factors go into deciding which succession option is best for a company. They include the type of business it is, the value the owner brings to it, whether there are qualified family members or key employees who want to assume ownership, whether the owner wants to retire and step away completely or not, whether there are partners, and more.
According to experts, there are some common alternatives.
Winding Down and Closing the Business
This route may be best for a small business owner who’s a craftsman and the only one in the enterprise with his skill. He or she may decide to keep on certain employees and give them a bonus so they’ll stay until the last job is done and so they’ll have money to tide them over for a certain amount of months while they find new work.
Selling the Company
This happens all the time. In fact, 39 business sales closed in Clark County in the third quarter of this year, according to data from BizBuySell.com, an online business-for-sale marketplace. The enterprises sold included a pool service route, dry cleaner, ice cream store, florist, doggy daycare, medical practice, restaurants and many others.
Business owners who sell should realize before making that decision that they likely aren’t going to get the dollar figure out of it they expect. This primarily is because the business, in losing the owner/operator, is “losing a valuable commodity.” Rowe said. “A lot of the goodwill, which is valuable to the business, resides in the owner.”
The difference between the asking and sale prices of those Southern Nevada businesses recently sold seems to bear out this phenomenon. Owners had asked for a revenue multiple of 0.67 but received, in the sale, one of 0.53, a 21 percent difference according to the BizBuySell.com statistics. Similarly, owners had sought a cash flow multiple of 2.37 but wound up getting one of 1.85, a 22 percent decrease.
Passing Down the Company to Family Members
This only works if there are potential heirs the owner believes are qualified to take over and if those individuals want to do so. Everyone in the company would need to know those specific family members were selected to take over, and the chosen ones would need to be groomed to seamlessly transition into the change of ownership and leadership.
Externally Recruiting a New Owner or CEO
What’s important to know when looking to replace the outgoing CEO or owner is that the business likely will have to pay the new person in charge a salary along with their own pay for a period.
“So, all of a sudden, when you look at the financials, you need to ensure the company can take that kind of a hit,” Rowe said.
Recruiting externally for a family business can get messy, as “it’s terribly disruptive, not only for the business but for the family as well,” Rowe said.
For instance, for whatever reasons, some family members might resent the owner for having gone outside the family and could cause problems, making it difficult for the new leader to be effective.
Key Employees Buying Out the Owner
This is a strategy that Borg sees often in her practice, which caters to small- to medium-sized businesses, ones with from two to 50 employees. If the owner has retired, oftentimes the new owners will want them to remain involved for some time and, to a certain extent, to ensure a successful transition.
With the options of family members or key employees assuming ownership of a business, sometimes financing is relevant and a method of which must be decided on and spelled out in the succession plan. Various ways to finance a takeover exist, from insurance policies to the previous owner holding a loan.
“That’s a big part that needs to be put in the agreement or the plan can fail,” Borg said.
How to Develop a Plan
Several experts agreed that certain steps should be taken in order to develop a successful company succession plan.
The first and most basic is to seek help from an attorney, certified public accountant, consultant, financial advisor and/or other professional to assist in the planning. These advisors will ask the pertinent questions and assist the owner or executive in deciding the best succession option for the company, given the specific circumstances of any business and company leaders. A business should have as many meetings as necessary to come up with a satisfactory plan before the structure decided upon becomes documented and formalized.
It’s also recommended the company be appraised early on by a valuation specialist or have the team determine how the enterprise will be valued. It is important to understand which areas of the company need work and which parts are excelling so improvements can be made to raise its value and possibly sell it at a multiple.
The next step in succession planning is to devise a short-term, interim action plan for the emergency of an owner or CEO suddenly being unable to do their job. Determine what the company will need as far as executives going forward. Then for each of those positions, analyze the skills, capabilities, and traits required to execute the jobs successfully. Starting with the CEO role, determine who, if anyone, already within the enterprise could fill those positions with the right development and training. If necessary, look outside the business and create a comprehensive list of the potential candidates and their qualification.
Once that list is compiled, it’s important to weigh whether or not that list of people will work for the company and if they’re in line with the company’s mission and culture. Often times, the first list is not always the best option and company leaders should make changes until they feel confident in the potential candidates.
Communication to employees and/or family members who could be part of the succession is key. They need to know what the plan might be when they agree to it. The buy-in of all those involved is essential and achieving that may require swapping out some of the people. This step might be best done in a meeting with hired professionals, as they can help mediate.
With everyone on board, and with guidance from professionals, key decision-makers need to agree on a structure, then have the pertinent agreement documents created. Those may include a buy/sell agreement, a family limited partnership agreement or related estate planning documents. The various advisors should ensure that all components of the succession plan—tax, estate and legal, for instance—work well together.
Lastly, communicate with the entire company what the succession plan is and remain transparent about it. Once all those involved are on the same page, the training and developing of the successors should be a priority.
Even when everything seems to be in place, it’s important to remember to review and update the succession plan every one to two years to ensure the plan is still relevant and all essential people are on track.
Although developing a succession plan may seem overwhelming and therefore often overlooked, succession planning experts agree the process is doable and, more importantly, hugely crucial and worthwhile. “If you open your eyes wide enough and if you’re open-minded about this, you can get through it and you can realize a positive result,” Rowe explained.
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