Thinking About Succession Planning Now

by | September 6, 2011

The term “succession planning” most commonly describes a company’s planning for its future. The issues typically discussed revolve around who will take over the company’s ownership and management upon the retirement of the current owners or partners. These are critical planning elements for any company but succession planning must also address the unexpected events that may force transition such as death, disability, or even divorce. Without proper planning, the unexpected scenarios could result in unanticipated consequences and create chaos within the company and with the company’s stakeholders. As the leader of your company, you must consider ownership, management and transition issues and put a plan in place that minimizes disruption for all involved.

Single Owner Companies.  A company with only one owner must consider whether the company will continue if he or she is no longer there to run the show. Two key scenarios exist: 

1.  Voluntary Departure.  In the situation of voluntary departure, the owner has the luxury of planning for his or her departure. These situations typically arise where the owner decides to cease operating the business due to financial, personal or emotional reasons such as retirement or changing career direction. The owner may opt to try to sell the company to an employee or other third party or close the company. Regardless of the owner’s choice, the planning should begin at least two years in advance of a potential transition.

            a.  Sell the company.  The planning process for the sale of a company allows the owner to position the company to potential buyers by formalizing financial statements, corporate documents and internal processes and understanding what’s an appropriate price or valuation of the company. It’s important to note that solo owned companies are often heavily reliant on the sole owner’s relationships with clients which greatly reduces the ability to sell the company. Once these formalities are completed, the owner can think about who the possible buyers are, the owner’s cash needs after the sale, and how the transition may occur. Price and payment/deal structure both play into who are the likely buyers. Once a buyer is found and a deal agreed upon, the key steps of transitioning management and clients may occur. The transition process varies based on the kind of business and may be an immediate break between the old and new owners or a longer term transition arrangement where the old owner remains with the company for a period of time after the sale. Furthermore, the transition may occur slowly where the new owner comes into client relationships prior to the deal closing. 

                b.  Close the company.  When planning to close a company, the owner must consider who will take over his or her role in the business. In planning to depart, the owner may stop actively managing certain parts of the business and transition these tasks to others. As with the sale of a company, the transition of critical business activities may be an immediate break or take many months or even years to fully transition.

2.  Involuntary Departure.  In a situation of involuntary departure of an owner, such as death or permanent disability, the transition must occur immediately. Without planning, the management of the company and the daily business activities are thrown into the hands of the estate or guardian. Planning should include the designation of one or more individuals familiar with the company and its activities to take over matters or pass them on to other designated individuals. Those with key employees have the benefit of continuity through the employees’ experience with the company and its processes. Defined processes and formal recordkeeping procedures for the company facilitate this process. A life or disability insurance policy held by the company allows the company to have sufficient funds to hire necessary resources to accomplish these tasks.

Multi-Owner Companies.  A company with multiple owners or “partners” has the added question of how an owner’s interest is purchased by the other owners in the case of a voluntary or involuntary withdrawal from the company.  These questions should be addressed in the company’s Shareholders’ Agreement (for a corporation), Operating Agreement (for an LLC), or Partnership Agreement (for a partnership).  Key areas for consideration are what the purchase price will be an how it’s determined at the time of the event, the terms of the buyout, and whether the price and terms are the same in all situations and for all owners.  

1.  Voluntary Departure.  The owners of the company must agree on how a voluntary departure of an owner will financially and culturally impact the company. Financially, the owners must consider what the value of the company is or, more importantly, what the value of the departing owner’s interest in the company is and how the company will pay for such as buy-out. The valuation should be reconsidered annually so that the figures match the reality of the company’s finances and to be sure the company can afford the buy-out. In addition, you must consider what rights the company and the departing owner each have regarding assets of the firm such as intellectual property or clients brought to the firm. If a non-solicitation provision exists that limits a departing owner from taking clients or employees with him or her, the parties must agree as to how such a provision will be enforced. In some cases, the parties can quantify the “value” of a client and allow a departing owner to “buy” the rights to certain clients or employees they would like to take with them. In addition, a company should work to develop the relationships with the company rather than with a specific individual. In doing so, the client will be more likely to stay with the company if a particular owner departs. The parties may also agree to have the purchase price for an owner’s interest differ based on the reason for departure. For example, some companies agree that an owner gets no buy-out if he or she chooses to walk away within some period of time following the formation of the company but does receive full payment of a formulaic valuation following that period. In other cases, retirement of one owner is contemplated at the start of the company and the parties agree to certain timeframes regarding any such retirement.

 2.  Involuntary Departure.  Involuntary departure occurs where the ownership interest of an owner transfers to a third party without the owner’s consent. In a multi-owner company, the case of involuntary withdrawal may take many forms including death, permanent disability, divorce, and bankruptcy. One of the key concerns for the remaining owners is maintaining control over the ownership. Generally speaking, individuals go into business together choose to do so intentionally. When a situation of involuntary withdrawal occurs, it poses some risk to the remaining owners that they’ll end up with a spouse, heir, or guardian serving as their new partner in the business. Planning ensures this situation doesn’t occur. A common structure to avoid the transfer of an ownership interest by law or by contract to a third party is to restrict the transfer of the ownership in the Agreement. The technical approach for each scenario may differ but accomplishes the goal of keeping the ownership interest in the company. Another involuntary departure may occur if an owner fails to perform his or her duties to the company as an “employee.” These duties typically include management, business development and/or client work. The company should implement the tools to allow the company to “fire” the employee-owner and purchase his or her interests. The distinction between owner and employee is important yet often overlooked by owners working together in a business. Setting clear expectations up front of each owner’s contribution to the company in terms of cash, services and other resources or expertise is crucial to building a relationship that lasts.

Best Practices in Succession Planning.

–  Document key company activities including recordkeeping and security access.

–  Designate an individual who knows how the company operates to fill your shoes if you are unavailable temporarily or permanently.

–  Set forth a list of wishes/desires for the business ownership in a Shareholders’ Agreement and Estate Plan.

–  Communicate the plan to the key internal owners and employees of the company.