Why Today Is The Right Time For Succession Planning By Business Owners
If you are the owner of or partner in a small to mid-sized business and you have been deferring succession planning, you need to adjust your thinking. If you are a partner in a professional services firm and you are allowing your clients to defer succession planning, you need to take action to change the thinking, of your clients. You need to understand why today, no matter what your age, is the right time for succession planning by business owners and you need to take action.
Many entrepreneurs do not start thinking about or taking action on succession planning until about five years before retirement. Although this is an understandable approach, it can put both the business and the individual's family at significant financial risk. Without a succession plan, the company could be forced to find ways to wait out the probate process before making necessary changes or before selling the company or installing new leadership. Without a succession plan, the company could also experience a potentially damaging leadership gap.
If the average entrepreneur delays succession planning until five years before a planned retirement and there is nothing that spurs him or her to engage in succession planning sooner, both the business and the entrepreneur will fail to maximize the value of the business. Succession Planning is a key strategy in fully maximizing the value of the business, which can bring great results over time. It is hard to believe that any entrepreneur or business owner would knowingly forego opportunities to maximize the value of their business in any way. Yet failure to take the time for succession planning has unfortunate results for entrepreneurs every day.
Joe is a 36 year old accountant who is a partner in the accounting firm of Jones, Smith and Brown. Joe is single, but he is responsible for the support of an aging parent who lives on a minimal fixed income. His business partners are his best friends. They created the partnership and opened the firm when they finished school fifteen years ago. While on vacation, Joe was killed in a boating accident. He has no will and the firm has no buy-sell agreement. His parent and his partners are now faced with the task of sorting out a financial and legal nightmare.
Dianne is a 43 year old financial advisor and managing partner of a financial advisory firm. She is the widowed mother of 13 year old and 10 year old daughters. Dianne's will states that her interest in the firm is to be shared in equal portions by her two children in the event of her death and that her mother is to act as guardian and financial advisor to the girls until they reach the age of majority. When the firm was formed more than twenty years ago, there was a buy-sell agreement which authorized the surviving partners to buy out the interest of any partner who left the firm for any reason on the basis of a stated value. Because the succession plan was never updated or revised, if Dianne dies today, her daughters will lose their interest in the firm and will receive in exchange only a small fraction of its current value. If Dianne should suffer a massive heart attack tomorrow and die, what will happen to her kids?
Frank owns a successful dry cleaning business. He has decided to sell the business so he can use the money to start a new business in the city to which he and his wife want to retire in fifteen years. Frank and his wife have managed the business by traveling back and forth between the six dry cleaning stores and relying on a customer service supervisor in each store. As a result, there is no strong management team in place to either buy the business or to help a new owner run the business. This failure will cost Frank hundreds of thousands of dollars in the sale transaction because it is causing the business to receive a smaller multiple. Frank's situation represents the biggest threat to most small businesses.
When professionals or business owners are young and starting out, they (like most of us) believe they will live forever. Most of these people also have limited capital to invest in the business or firm. On the basis of reasonably good advice, they incorporate or create partnerships based upon limited growth expectations and average life-expectancies. Then they become busy building the firm or the business. They focus on managing work flow and growing the business and increasing revenues. Unless something significant occurs in the life of one of the original partners or owners they never quite get around to revisiting their succession plans. In fact, one recurrent theme in small business partnerships is creation of the partnership without ever getting the legal documents completed.
The kinds of events that most frequently lead to a revision or a review of succession plans include:
- Someone they know becomes ill with a life-threatening disease
- They become grandparents
- Issues or problems arise within the partnership
- New partners are joining the firm
- Someone they know dies tragically and unexpectedly.
Most strategies to maximize the value of a business need time to achieve optimal results. Unfortunately, too often business owners and partners discover that they should have revised their succession plans when it is too late. It is frequently very difficult, if not impossible, to purchase additional insurance on a partner after that person has been diagnosed with health issues. It is very difficult to build a management team in the 18 months before a sale. It is very hard to win a commitment from key employees when they know you are selling the business.
Succession planning is important for the firm or the business in terms of the organization's stability in and after a leadership crisis. Succession plans clearly play a critical role in determining how business ownership issues are to be resolved when a partner leaves the firm. Succession plans also play a critical role in providing the guidance needed by the firm to train, prepare and position the individual who will assume the leadership role of the person leaving.
There are approximately 15 to 18 million privately owned businesses in the USA, according to a recent study by the Atlanta financial services firm White Horse Advisors. It is projected that 60% of those companies (9 to 10.8 million) are owned by Baby Boomers. Most of the Baby Boomer business owners will exit their companies in the next ten years. But only 10% of those who plan to leave have an up-to-date written succession plan.* The companies they leave need an orderly transition of leadership in order to remain stable in their markets. Further, new issues are arising in businesses and services firms, including those listed below. Succession plans that have not been revised in many years probably did not anticipate or address such possibilities as early retirement on the one hand or working well beyond traditional retirement age or changing valuations. More importantly, plans that were started but never completed and plans that were never started leave companies and entrepreneurs and their families at increasing risk. For example, if your accounting firm has a succession plan written many ago, there are probably several inadequacies in its terms:
- The valuation of the business is probably outdated
- The ownership proportions might be out of balance as the company has grown
- The buy-sell agreements might not reflect inheritance issues
- The buy-sell agreements probably did not anticipate the possibility that the managing partner, instead of retiring at age 70, might want to sell a portion of her share in the company and become a part-time member of the firm at age 50 in order to help her husband start a business.
- The preparation of the next generation of leadership has not been addressed
- The next generation of leadership has not been identified and brought into partnership in the firm.
As all of these considerations indicate, today is the right time for succession planning. Businesses change, people change, the world changes. Most businesses or firms cannot afford to wait until the owners reach a distant chronological age. Nor can these businesses afford to leave their future to chance. Every privately held business or partnership should immediately take steps to create considered and up-to--date succession plans. Once a plan is created and funded (many plans are created but never funded), it should be reviewed every three to five years to ensure that it is adequate, current and accurate.
*Laura Raines, "Owners Should Have Exit Plan, " Atlanta Journal-Constitution, Friday, November 14, 2008, R1.
Copyright 2010 by David Wolfskehl
David Wolfskehl is President and CEO of The Succession Planning Group, a member of the DGW & Associates Family of Companies. The Succession Planning Group helps professional services firms assistance in having the right conversation with their clients. You can read David's complete biography at http://www.tspgroup.com/AboutUs/OurTeam/David/. David has been an entrepreneur and a guide for entrepreneurs throughout his adult life. After successfully selling his business in October of 2005, David began offering workshops on unlocking the power of your employees. He also started Networking4connections, a consulting firm focused on teaching professionals how to win opportunities to promote their business to A clients.
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