How Good Is Your Succession Plan?
As a CPA, I try to follow the following five best practices to meet the specific needs of clients.
The term “succession plan” gets thrown around all the time, but what is truly meant by this term can vary dramatically, depending on the speaker, the audience and the point in time when the plan is expected to come into play.
For instance, your client’s banker may have one idea about the documentation they need in a loan file that lays out a game plan if your client, the “entrepreneur extraordinaire,” should die suddenly.
This is a far cry from the “succession plan” your client envisions, such as imagining turning over the reins to his or her business smoothly and riding off into the sunset in financial bliss.
In fact, succession plans always entail a contemplated change in the ownership and management of any business and having the right elements in your client’s plan can have a huge impact on achieving successful outcomes. Here are five elements to consider as you work to meet the specific needs of your clients:
Element #1. Clarifying Owner Goals
The first and most critical element is having crystal clarity about the goals of the owners. While this sounds easy, it rarely is. This is where your client/business owner has many competing goals and a lot of emotion attached to how they are realized. For example, I had one client whose only direction before he passed away as CEO of his family owned-company (at a relatively early age) was to make sure his employee “family” was taken care of, since he knew his family members (inactive in the business, but nonetheless, co-owners), would be financially set in any case. After his death, the family members seemed to want more for themselves, which made it very tough to retain and care for the employees. At least, we had some sort of bull’s eye on the target because without a target it’s pretty difficult to know where or how to aim. However, hitting the target can and in this example, did involve maneuvering through some minefields.
Element #2. Willing Seller/Willing Buyer
Many a parent/entrepreneur has wishful thinking that can span decades about a child or children or key employee who may want to own their business someday. Others look forward to having a big company scoop up their enterprise for a premium price or, better yet, take their company public and make a killing. Whatever the dream or scheme of the owner(s), ownership changes usually work best when the parties are motivated and onboard, rather than being forced to act under duress. Forward-thinking, honest discussions among the prospective buyers and owners along with careful grooming and preparation over time ensures a much better outcome than wishful thinking and rushed decision-making.
Element #3. A Systematic and Sustainable Business Model
There is a reason they call it succession: the business is supposed to continue. That requires having and keeping all the essential components of your client’s successful business model in place. Some of the obvious areas that support successful continuity are strong leadership and management, best-in-class employees, continuing solid demand for product and services, great fiscal management, a spirit of innovation and passion to succeed.
Element #4. Financial and Tax Terms That Are Efficient
Many clients object to “giving” stock to children or key employees. After all, they are keenly aware that they became owners the hard way, by funding their own equity followed by the sweat and tears expended in building the business into a successful enterprise. As CPAs, we know that that “gifts” of stock and other structuring options can save a huge amount of tax dollars. We just need to find a way to reconcile these vehicles with our clients’ feelings about the mechanics.
Another critical part of the equation is funding the transaction. With a generational transfer, relatives are usually willing to live with a payout over time. This can also be true with transfer of ownership to key employees. It becomes less attractive when the sale is to an unrelated third party, which makes bank or other external financing necessary. Depending on the type of business, asset make up, dependence on the financial strength of the seller (i.e. personal guarantees securing financing or not) and track record of the business, obtaining outside financing may be a snap or an unachievable task. Needless to say, there are many ways to structure business transitions to make them manageable from a cash-flow, financing and tax-efficiency standpoint. That’s why CPAs are critical to the process, right?
Element #5. Implementation Approach That’s Rock Solid
Too often, a brilliantly crafted succession plan falls short of its goals due to the lack of follow-through after the sale. Outside of the business, strategic and ongoing communications are needed to make customers/clients aware of the succession plan and what it will mean in terms of their relationship to the business. For the most part, the message is that “if you loved us before, you will love us even more in the future.” Other outside constituents, including suppliers, regulators, bankers, important community or political connections and others also need to be kept in the loop and persuaded that the transition will be smooth and positive for them.
Inside of the business, the employees — the most important asset in the sale — also need attention and tender loving care if they are going to stick around. This is especially true for key executives, who may require “stay bonuses” to maintain their interest, particularly when the sale is to an unrelated third-party that is part of a larger entity, and the executives know that consolidation of positions is part of the program. In order for the succession to succeed, these key executives not only need to be retained, they also need to receive the grooming that equips them to run the business. This is no small task if these anointed leaders are taking on many new tasks, while trying to train someone to fill the role they had before the sale. It becomes an especially impossible task if they don’t have the training or the capabilities to step into the big, empty shoes of the owner(s).
Although the closing documents may legally define the ongoing post-sale relationship between buyer and seller, taking the right steps to make it functional is vital. In many situations, there may be a continuing consulting or employment relationship that can be unnerving to both parties, unless a well-structured and mutually agreed upon plan is in order that delivers the expected benefit. Other areas to define include how much information will be shared between new and past owners and whether any continued decision-making role will exist for the former owner(s). Having a well-defined process and quick resolution of disputes included in the legal documents, as well as identified professional advisors who can help keep things on track in a positive way, really helps facilitate the post-sale phase, making it more productive and comfortable for all concerned.
In an upcoming article I will divulge what the ideal timing for transitioning management is as well as discuss ownership controls of your client’s business. In the meantime, utilizing some of the above elements with your clients should prove interesting.
Gustavo A Viera CPA
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