Lenvest Financial Advisors
526 Central Ave., Suite 200
St. Petersburg, FL 33701   USA 
 
Tel:  727-894-7888    Fax: 727-821-3030

 
 
Succession Planning 
and
Equity Transfer
 for the 
Closely-held Company
 
 Mr. Len Russek
  
 Very little is written on the subject of succession planning and equity transfer in publications which are read by the owners of closely-held companies.  Perhaps this is because the issues are quite complex, and the uniqueness of each situation defies the promulgation of standardized solutions.  Or, perhaps it's just due to the fact that writing about issues which attract attention to one's mortality makes everyone uncomfortable.  

 The children of  business owners don't wish to appear greedy or pushy by bringing up the subject, and the owner's spouse is frequently not eager to broach the subject except at those times when the owner is in poor health or complaining about business.  Key employees rarely find a way to bring it up, and friends or outside advisors hesitate to bring up the subject for fear of offending the owner.  So, how does this critical subject typically get addressed, if at all?  In two primary ways;  
  
                            1. By the owner's initiative and insight.  

                            2. His estate planning advisor brings it up and presses for action.  
  

 If there is one area that defies all rules-of-thumb and any standardized solution it is certainly the area of equity transfer and succession planning for closely-held companies.  These situations are as different as the people involved, and require significant creativity to resolve.  From my experience coordinating the efforts of those professionals advising the owner, the talents required  to effectively develop a plan include estate planning, life insurance, taxation, corporate governance, executive selection, human nature, business valuations, mergers & acquisitions, and a basic understanding of the owner's particular business.  It's unlikely that a business owner can find one advisor with all of these talents who can guide them through the issues.  A team approach works best.  

 More than anything, the process requires time if all aspects are to be properly considered.  If put off until too late, only compromises resulting in mutual dissatisfaction can be achieved.  However, most owners are so busy running their business they find it difficult to find the time to do this type of planning.  The following is a discussion of a few of the myths and misunderstandings that exist on this subject which may cause business owners to think more carefully about the possible consequences of not planning for their succession.  
  

    Management succession planning is something done by only large  
    companies.  It does not apply to closely-held companies. 
 In most large companies, management succession planning has become institutionalized by the personnel departments as an expected practice.  CEO's of large companies are frowned upon if they do not have a clear succession plan in place.  Management guru, Peter Drucker declares that succession planning is one of the CEO's primary responsibilities.  However, CEO's of closely-held businesses rarely have anyone pressuring them to develop a succession plan, even though it may be much more important for them to have one in place.  

 Failure to have a clear management succession and equity transfer plan in place for the closely-held company can create bitter feuds between heirs that cause emotional scars which never heal.  It can result in management upheavals that threaten the continued viability of the company.  In many of these cases, family wealth is dissipated by either a lower business valuation due to losing key employees to competitors, or by attorneys fees as a result of the family feud.  
  

    Succession planning is unnecessary for closely-held companies  
    when the owner's children already work in the business. 
 If the owner has not made it clear which child is to be the new CEO, and what each of the other children's responsibility and authority will be, childhood rivalries can be expected to create havoc in the company.  Power struggles between employees at large companies where the CEO has failed to develop a succession plan are ugly, but they are mild compared to those at closely-held companies which may have the additional emotional fuel of unresolved childhood rivalries.  

 What if a capable nonfamily member has been the second in command for several years, and is quite capable of running the company?  Should he be promoted to CEO and expected to report to the surviving spouse who may know very little about the business?  Are there special situations created by children born different spouses.  What is the potential for conflict developing between a nonfamily CEO and the children who may now own more shares of stock than the CEO?  Will the children be capable of voting their shares in a block to subvert the CEO's authority?  How can this be balanced while protecting the family against the CEO either being unable to run the company, or choosing to run it contrary to the best interests of all the stockholders?  

 For the larger public companies, the laws of corporate governance and the federal securities laws provide ways to address the situation where the CEO is not equally representing the best interests of all the stockholders.  However, closely-held companies are typically operated in ways that are in the best interests of just the major stockholders.  If the interests of the minority stockholders differ, they are often just politely ignored.  Once there are several individual family members who are minority stockholders and only collectively comprise a majority, the way in which the company operates will likely change.  
  

    If children who work in the business are too young or inexperienced  
    to assume the helm, an outside buyer must be found. 
 While this must be addressed on a case by case basis, owners may be making a mistake if they believe their only option is to find an outside buyer if none of their children are capable of running the family business.  There are talented executives available who can be hired to run the company for a specified period of time until one of the owner's children has matured into the CEO role.  If compensated appropriately these executives may take pride in mentoring the owner's child and helping them prepare to take the helm of the company.  This is not an easy approach.  It will be difficult to achieve and human nature may prevent its success.  A lot depends upon the character of both the executive and  the owner's child.  
  
 If a solution such as this can not be found, then a plan to sell the company needs to be developed.  The children should be informed of the plan and need to understand that a new owner may not want them to remain as employees.  Many buyers will assume the children are not productive employees and expect the seller to address the situation of his children's resignation with them personally prior to closing.  Some buyers will avoid situations where the seller's children hold upper management positions, and others will just discount the price they are willing to pay based upon their estimate of the costs anticipated to replace the seller's children with other employees.  
  
    I can't let my key employees know that I am thinking of selling my  
    company until just prior to closing.  If I do they may leave. 
 Many business owners feel that by not discussing their plans, they are retaining key employees who might leave if they knew of the owner's intentions.  They often overlook the fact that their employees are very much aware of what is going on and are quite distressed at being left out.  The owner's silence has allowed the employees to form their own expectations, and they frequently expect the worst.  Key managers may talk amongst themselves about the owner's age and prospective retirement, but never bring up the topic with the owner in person.  Privately they may worry about how their relationship with a new owner might not be as favorable as what they have now and how they might have to face being terminated by a new owner.  The uncertainty of the situation may cause some employees to decide to leave.  

 The more assertive employees may approach the owner about the possibility of buying the business, only to be rebuffed by the owner's perception that the employee doesn't have any money.  However, if the company has been profitable with strong cash flows, the key employees may be able to obtain financial backing to buy the business.  If the company's annual cash flow is at least $1,000,000 per year, some venture capital firms and leverage buyout funds are interested in backing solid management teams in buying out a retiring owner.  For smaller situations, the SBA will guarantee loans (up to 75% of a $1,000,000 loan) the proceeds of which can be used to purchase the business from a retiring owner.  

 To preserve the trusting relationships built over the years, key employees need to be confided in about the owner's plans to sell and perhaps offered the opportunity to purchase the company.  In most cases, the discussion must be initiated by the owner since the employees will be unable to initiate it for fear of appearing pushy or eager for their benefactor to retire.  Failure to openly discuss this subject with key employees can cause them to feel excluded and not valued.  Until the employees have been given the opportunity to try to purchase the business, they may be emotionally unable to fully support the owner in selling the business to an outside buyer.  

 One approach is to offer the key employees a period of time during which they can try to raise the capital to buy the business, with the understanding that after the time period has lapsed they will help the owner sell it to an outsider.  Some owners who have wanted to sell their business to their key employees have engaged me to help the employees determine how much the business is worth, and to help them arrange outside financing so they can purchase the business.  Large companies have for many years taken this approach when divesting subsidiaries.  Owners of closely-held companies are beginning to appreciate the merits of allowing the company to pay for outside assistance for the key employees.  It may be a unique approach, but it works.  
  
  


This article was written by Mr. Len Russek based upon his experiences helping owners of closely-held companies develop succession plans and/or sell their companies to outside buyers.  It may be copied or plagiarized from at the readers desire.    
   
Lenvest Financial Advisors, St. Petersburg, Florida, 813-894-7888 - www.lenvest.com