The Confusion of Exit and Succession Planning

by | September 2, 2014

Blog written by Michelle Bomberger, Equinox Business Law Group

The terms “succession planning” and “exit planning” are often used interchangeably among business owners and their advisors because in closely held businesses they are innately connected — owners are often also the leaders and executives.  However, they should be addressed by the business as separate plans because the questions of leadership continuity and ownership transition are different and unique.  Furthermore, understanding how these plans address the leadership/management and ownership dynamics in your business will serve you well in the long run as your business changes.

Succession Planning.  Succession Planning is the plan for leadership and management continuity in the business.  A leadership transition may be expected, such as the retirement of a senior level person, or unexpected, in the case of an unexpected death of an executive.  In both cases, the question of who will take on the leadership or executive role arises.

A succession plan should evaluate people dependencies in the business.  We know the mantra:  “You should always be looking for talent;” and we take this advice to heart, constantly seeking qualified employees who can serve our clients.  However, we rarely evaluate who will move into the executive roles if we are no longer there.  To properly plan for succession, you should understand the organizational shifts necessary if a key person departed a leadership or management role.  Your plan should consider, for each key position, what the organization will do in the short term and in the longer term to fill that role.  The plan should include what financial resources as well as leadership and technical skills the company will need to fill that role.  Once you have identified the company’s needs, you can then begin to think about how the current team will shift and what new skills should be hired.  The plan is finalized when you write it all down and share it with the executive team and the ownership.  At least once a year and any time you have changes in leadership, you should revisit your plan.

Exit Planning.  Exit planning is the plan for ownership transition of the business.  Like succession planning, the ownership transition may be expected, such as a planned sale, or it may be unexpected, in the case of the death of an owner.

–        Internal Ownership Transitions.  Most closely held businesses prefer to control the ownership of the company for both financial and control purposes.  Therefore, an understanding of how ownership will transfer in the case of a voluntary departure or death of an owner is critical.   The transition plan is usually outlined in an agreement among the owners which is called a “Partnership Agreement,” “Operating Agreement,” or “Shareholder Agreement” – sometimes also called a Buy/Sell Agreement.  These documents outline the restrictions and allowances concerning the transfer of ownership.  For example, an owner is typically prohibited from transferring his or her ownership interest to any third party without offering it first to the company and then to the other owners.  Often, the other owners must also approve of the third party as well for any transfer to occur.  These provisions apply to a potential transfer by an owner caused by death or permanent disability, divorce, or an offer to purchase by a third party. By incorporating these provisions, the owners are able to control who owns the company and the price of any transfer.  Without a Buy-Sell Agreement in place, ownership can readily be transferred without the consent of the other owners.  In the case of a death, the interest may pass to a spouse or other heir through the deceased owner’s estate plan – and we all have heard stories of owners who inadvertently end up in business with spouses of their business partners or in fights with those spouses as to how much the business is worth.  Getting these particulars in writing will limit disruption to the company if the unexpected occurs.

You can see how the concepts of succession and exit are intertwined in a closely held business.  In many cases, the owners are also the leaders and managers.  If something happens to an owner or the owner wishes to leave, he or she leaves the position of manager (“succession planning”) as well as the position of owner (“exit planning”).  Without key planning documents, such as an owner agreement and employment agreement, in place that describe these differences, the company could have an owner who is no longer working in the business or an owner that the company doesn’t wish to have.

–        Sale of Business.  Another aspect of exit planning is the planned sale of the business by all the owners to a third party.  This is a challenging process and most owners don’t know where to start.  The successful sale of a business requires a team of people to support you in understanding the right buyer, timing, structure, and personal financial implications of the transaction.  The team should include a business broker, financial planner, accountant, business attorney and banker.  Your plan will begin with your broker helping you to evaluate the likely buyers of your business – are they family members, employees, competitors, or other third parties – and the value of your business to each of these potential buyers.  They can also help you consider what activities can build additional value in the company for a future sale.  Your financial planner will help you determine if the value projected for the business is sufficient, when added to your other financial assets, for your future financial needs.  Your business lawyer or general counsel will help you identify and mitigate risks that a potential buyer may see and prepare for due diligence or document requests by a potential buyer.  Your accountant can review financial record keeping to be sure the books are clean and easy for a potential buyer to understand.  Between determining the right buyer, building additional value in the business, and preparing for the due diligence process any buyer will undertake, you should begin this process a few years before you plan to exit the business.

Conclusion.  You may play out many different scenarios of ownership and management transition and consider which ones pose the greatest risk to your business.  With these risks in mind, you may create the right plans to mitigate these risks, so as to ensure the company is prepared and protected when an expected or unexpected event occurs.