James P. Tate, Cogent Management Resources, LLC
February 26, 2010
Recent studies have shown that over one third of all businesses collapse when the owner retires or dies. The prime reason for this unnecessary demise is the lack of foresight and planning by the owners. Most business owners are engrossed in their work and enjoy making their business a success. Because they lack staff resources, the small business owner is directly involved in the day-to-day activities of running the business. Little time, or attention, is given to planning for the long-term future of the enterprise.
Providing for the continuity of the business is vitally important to the business owner. In many cases, the business must fund the owner’s retirement life style. While many small business owners expect to continue running their businesses until they die, the cruel truth is that Mother Nature has other plans. As we age, our health declines and we undergo a change of perspective. Many business owners realize that they no longer want the time pressure and stress of running the business. They are ready for a more relaxed lifestyle and more family time.
For some business owners this realization comes too late. Without a plan for retirement and transferring the operational duties to other managers, the small business owner must continue in his job. Selling the business at this late time will usually yield a reduced price. The business has not been set up as a strong enterprise to command a high sale value.
Preparing for the future and making plans to transition the business to family members or managers is a sensible and important task. Successful transition of the family business can provide the owner with assets and income for a very comfortable retirement. It can give him the assurance that his heirs will be provided for after his death.
There are a number of important steps to be completed to successfully transfer the business. This article will review the steps to be taken and offer sources for help in accomplishing these tasks.
Why Do I Need Transition Planning?
The goal of transition planning is to pass on the financial and leadership responsibility for the company to a younger generation of managers while maintaining a healthy, growing enterprise and family wealth. There are a number of important factors to consider in preparing for the transition. Foremost is the family ownership and its involvement in the business. How is the ownership of the business established at present? Are family members involved in the business at this time; or are they planning to join the business at a later time?
A second factor is the financial goals of the family members. Grown children may have their own financial agenda in life. How does this agenda fit with the business and the rest of the family? What does the family think about the business? How does the business fit into the family? Is the business the consuming passion of all the family members or is it only a source of casual interest to them?
A third factor for consideration, is the goal and strategy of the business. How is the business being operated at the present time? Is it a “cash cow”, or is it in a growth mode? What are the realistic prospects for the future of the business? What is the financial condition of the business? Is it sound enough to provide income streams to the retired owner and other family members who will run the operations?
Setting Up the Transition Plan
Now that we have asked the hard questions, it is time to craft a solution. There are several steps that should be addressed in developing the transition plan. One, very obvious step, is to establish a strategic plan for the business. A strategic plan is a well thought out, objective assessment of where the business is today; where it needs to go and how to get there. Creating the business strategic plan requires a great deal of hard, unemotional study and cold-blooded evaluation. An outside consultant can be of value in giving you the objectivity necessary to make a sound plan.
The steps in creating a business plan require the business owner to make assessments of the corporate strengths; weaknesses; opportunities and the market conditions (both today’s market and the potential future markets). Answering these questions sets the platform for where the business is today. The second step is to conceive a vision of where the company should be at the end of a specified time period. You must ask the question, “How do I want the company to look in 5 (or 10) years from now?” Now we have the two ends of our journey, the beginning and the goal. The next step is to develop a path to take us from where we are today, to where we want to go. This path should be clearly defined and have objective measurement points to enable us to know when we are on course. If this looks like a daunting or wasteful exercise, remember, you can’t reach a goal unless you know clearly where it is.
Yet, the business strategy is really the second step in the process. Before the business can develop a strategy, it is very important that your family create its own strategic plan. Where is the family going? How do the second, and third generation, family members perceive their lives in relation to the business? Are they eager to join the business or do they wish to pursue their own interests? Does the family live for the business or does the business only exist to serve the family’s goals?
The most effective way to develop a family strategic plan is to set up a family retreat, away from the distractions of daily life, and ask the hard questions. It is important that the younger generation be allowed to answer these questions without fear of disappointing or angering the older generation. The financial requirements of each family member should be identified to the individual. It is beneficial to have a professional financial advisor assist each family member develop a comprehensive financial analysis of his situation. These financial plans are confidential for each member. By understanding the financial resources necessary to achieve his goals, each family member will be able to put the business in the proper context in his life. The question of estate planning will become to be apparent to all the family members at this time.
Estate planning is a creative and complicated field with a wide range of options for any situation. The discussion of general estate planning, for business owners, will be left to a later article.
Selecting a Successor
Having established a family plan and a business strategic plan, the next step is to decide on a successor. This task may take months or even years and will be the major component of the transition plan. Choosing a successor can occupy a great deal of time and lead to dissension within the family. Looking objectively at the task can reduce the potential for family conflict. Several tasks must be addressed in selecting a successor. The most obvious question is whether the successor will be a family member or a non-family member.
A second concern will be to identify the skills necessary to lead the business in the future? (Now, you should begin to see why the business strategic plan is a necessary prelude to the successor selection!)
Third, what training should the heir apparent undergo before taking over the business. This training process should have a timetable and measurement points. The business owner should be prepared to relinquish, completely and permanently, operational responsibilities to the successor at a designated point in time.
As with all plans, the business owner must be committed to its success. He should be mentally prepared to allow the successor to take active management control of the company. He must construct policies for management roles and accountability for the successor.
Planning For the Unexpected
As Robert Burns sagely wrote, “the best laid plans of mice and men gang aft aglay…” All plans are subject to unforeseen surprises. In the case of a business transition plan, some surprises can be devastating to the business and the owner. It is important to identify the most serious impediments to the plan and develop contingency plans for these surprises.
The most dangerous surprise is the premature death, retirement or disability of the owner. Operational plans must be prepared for a speedy transfer of power in the interim. It may be necessary to provide financial safeguards to enable the business to weather this storm.
A family is a dynamic institution, constantly undergoing change. Changes in the family structure due to death, divorce, marriage, and the birth of children could lead to changes in family goals and could affect the transition plan.
No one likes to think that he will outlive his children. Nevertheless, children predecease parents. If the chosen successor were to die, what affect would this shock have on the transition of the business? Will there be time enough to start the selection process over again from the beginning? These are difficult questions. The answers will not be easy. However, the success of the transition requires that we address these possibilities and formulate a precautionary action plan.
Where Do I Go From Here?
This article has attempted to explain the need for a business transition plan. If you suspect that this plan is important to the long-term success of your firm, what should you do?
There are three answers to this question. The easiest solution is to ignore the problem and let fate decide the outcome. Assuming you are not comfortable sticking your head in the sand; the second option is to assemble your own transition plan.
Many busy entrepreneurs elect the third option. They seek outside assistance in developing their transition plan. This approach is usually the fastest, and in many cases, the most economical way, to prepare your company for its inevitable transition. A knowledgeable and experienced consultant can be a powerful resource to guide you to success. Because many of the goals of you, your heirs and your company are financial in nature, you may wish to select a financial advisor to lead your team. Your financial advisor may wish to draw upon the expertise of, accountants, family psychologists and lawyers to formulate a successful transition plan.
Whichever option you take, the successful implementation of your transition plan may offer the chance for greater financial security for you and your heirs.
James P. Tate is a Managing Director with Cogent Management Resources and a personal financial advisor with Investors Financial Advisors in Roanoke, Virginia. Mr. Tate has worked with several family-owned businesses to assist them in the successful transfer of ownership and management to the second generation.
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