When the change is unexpected, and you haven’t prepared in advance you may not be able to protect your family business – and often your family – unless you can create an ad hoc solution – not always easy in times of stress.  It is much better to have in place, pre-arranged exit strategies that are acceptable to all involved.  The ideal time to create these exit strategies is when the business is started, or when everybody’s getting along and sees the wisdom in preparing for the future, not after a problem has arisen.

Here’s how to create exit strategies, and the underlying compensation plans that support them (plans that that take into account both equity and performance issues), as well as, some thoughts on how to more smoothly make a change when needed.

Prepare For the Future

The first thing the family must address when facing a change centers on performance differences – how much and how – family members get paid and how an individual’s pay may not relate to how much of the business s/he owns.  Many family businesses are run to take maximum advantage of the Tax Code, which can distort salaries, bonuses and benefits.  If someone leaves, and compensation has been distorted, it adds another complication.  It’s better to initiate a competitive (market or industry) compensation program before any potential challenges arise.  Salary termination, or a salary continuation program, based on a market salary can then be factored into a buyout.

In many family businesses the parents insist on dividing company ownership equally among the next generation.  When this happens, resentments can arise.  Those not working in the business are concerned with continuing to get the distributions and benefits they’ve become used to under mom’s and dad’s rule.  Their siblings working in the business are concerned with earning a good living, keeping money in the business and growing the business for their children, or for eventual sale.  What mom and dad paid those not working in the business is often seen as “allowance” money and as the business changes hands, continuing such payments can cause deep division within the family.  If the company gets financially stressed, things can become even ugly.

• Game Changers and Tools
  • What are considered friendly partings usually occur through retirement, sudden or accidental death, prolonged sickness and/or, permanent disability.  Insurance can fund many of these possibilities.  An agreed upon valuation and a payment plan, tied to the amount due, a reasonable interest rate and a timetable for the payout, round out the options;
  • Partings considered unfriendly usually occur through divorce (NB – unless protective steps are taken before a marriage, a family member’s ownership interest can be subject to marital distribution), some disabilities, financial failure, etc.  Insurance can cover some of these contingencies, but not all.  A payment plan and valuation are key in these circumstances, coupled with signed spousal consents (in which the spouse agrees to surrender all claims on business equity in exchange for a minimal sum, usually $10 or less), as appropriate;
  • When prepared in advance, these documents can cover all family members and all eventualities the business might face in the future.  They can also establish terms and conditions that will apply to bringing in new family members – both for jobs and ownership.  The plan, to be most effective, will need to include a regularly updated valuation formula.  Get guidance from your CPA, Management Consultant, and/or Business Appraiser.
• Family transitions don’t usually “fit” into traditional valuation models. Discounts on the value of equity for lack of control, long-term penalty periods and the like are not usually put into play, though rights of subsequent generations to business ownership are sometimes restricted.  Some approaches, and how they work, follow:
  • Gifting – each taxpayer is currently allowed to give tax free gifts of up to $13,000 a year to anyone they wish.  Gifting has been used frequently to transfer equity to next generation members.  If the business has a high value, however, it can take a long time to transfer.  Moreover, if the family member is not working in the business and the business does not pay dividends, ownership only has value upon business liquidation, or sale, something that is not usually attractive to other family members working in the business.  In addition, gifting opens the door to challenging future valuations, as it is seldom tied to an objectively determined value.
  • Buy-sell agreements between the generations and among siblings – this allows business ownership to be transferred, at a mutually agreed upon price and terms acceptable to all family members.
  • An ongoing valuation model – In transitioning from one generation to the next, it’s important to establish a fair price (that recognizes the needs of the selling generation for retirement funding and end of life care and the needs of the next generation to pay as little as possible for what would normally be inherited (in buying, though, many inheritance tax issues are bypassed.)):
    • An objective, expert generated, valuation should be commissioned by the business. Often the company’s Management Consultants and/or CPA’s will complete this work.  Valuation is both a science and an art and, depending on which approaches are taken (usually a valuation firm will calculate value based on several approaches – sales of comparable businesses, if details are known; formula approaches; cash flow or projected income models; and/or, net worth calculations; and/or, industry norms).  Using a number of approaches will generate a range of values that can be weighed and applied.  A final valuation amount will be the compilation of these values and leaves room for interpretation, while still being defensible if ever legally challenged;
    • Parental income needs in retirement should be considered. Often parents will tie their selling price to their income needs, expecting their payouts to fill in any gaps between retirement funds, investments, healthcare needs and Social Security.  If the business in already in the hands of the current generation, income needs in valuation should be indexed as closely as possible to the least affluent family member active in the business.  This indexing has the potential to blunt possible objections from family members not active in the business, wishing to challenge valuation on a fairness basis.

When That Day Comes

• What are the signs and what do you do when they occur?
  • The first sign is a pattern of consistent non-performance (against agreed upon terms and conditions of employment set for all family members);
  • A second sign is an aura of “poisonous” tension among family members; and/or,
  • A third sign is a family member’s failure to comply with agreed upon (collectively voted) family decisions and/or using “family” relationship as a basis for self-dealing.
• Asking a family member to leave, or tell other family members you’re leaving is a delicate matter.  When leaving is forced (performance issues) the news generally comes from the family  member leading the business.  When voluntary, the family member leaving can have considerable flexibility on how, and when, to break the news:
  • Any announcement must either identify and present performance and/or personality issues as objectively as possible, or agreement must be made that an “agreement to disagree” has occurred and a change is necessary.  I recommend using a three-strike approach to reaching any change based on performance – Strike 1 – Let’s talk about why current performance isn’t working and agree on changes to make the problem go away; Strike 2 – Review what was decided in Strike 1 confirm agreement on the Strike 1 resolution. Find out, what wasn’t understood?  This leads to, “let’s put a new agreement in writing.”  If we don’t correct the performance with this agreement and the problem persists, we both agree that you are choosing to leave the business; and, Strike 3 – “Our written agreement isn’t working for either of us, we consider this most recent incident your resignation.”
  • When a member is leaving, agree on (or, if needed, impose) a suitable transition period (normally better to do, ad hoc, rather than pre-define, since how a transition occurs can take edge off family conflict – the decisions are not just business, after all); and,
  • If possible, allow the departing member to decide how, what and when, to tell the rest of the family.

Removing a family member from the business is not easy and it’s not often pleasant, but protecting the business for the benefit of the last generation (who may be depending on the buyout monies for their retirement), the current generation (both those working in the business and those benefiting from ownership) and future generations, is a goal worth pursuing and worth doing right.

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Ownership of the family business is often gifted more like an asset than as a treasured heirloom, with less though given to issues of being treasured or maintained.  It is seen as an entitlement or an annuity.  But ownership in a business is not the same as ownership of a bank account, or uncle Harry’s portrait.  A business has a life of its own and has its own identity.  Nobody is paying interest on its worth – it needs to be worked, nurtured and allowed to respond to its customers’ wants and needs.  If you are offered the gift of ownership in a family business, make sure you are willing to invest in the gift.  If not, ask for your inheritable interest to be converted to its cash value and paid.

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How can you be open to the unexpected?

1. It’s not over ‘til it’s over.  Remember, you can be pursuing a course of action, but still make changes – even reverse course – until you reach your final decision point [I was once involved in a deal that was all but done when the owner changed his mind about selling at the closing.  “I’m not ready to go,” he said. No Deal Is Done Until the Papers Are Signed, Sealed and Delivered] ;
2. Never count anyone out.  As you get closer to your decision point people who you may not have considered may unexpectedly step up to be counted.  If you are too locked into your initial choices you could miss out on an opportunity you haven’t anticipated [in the sale of one family business, two sons were vying for control.  After a series of activities working together planning for succession, the brothers changed their minds, switched positions, and that changed everything];
3. Be alert .  Nothing happens in a vacuum, the marketplace, the economy constantly change.  Circumstances may reveal other possibilities you can take advantage of at the last minute [Last minute changes in a deal make it better for all parties concerned].

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There may be paid managers and staff to perform some or even all of the day-to-day tasks, but ensuring an adequate return on investment (blood, sweat and money) is the leader’s responsibility.

There are two components of an adequate return: time invested must be compensated through salary, benefits and perks; AND, money invested must be guaranteed a fair rate of return plus a premium for the level of risk assumed. Adequate returns do not just happen, they are achieved through planning and action. This commitment involves setting realistic, quantifiable goals; taking the steps necessary to attain the goals; measuring the results; and, adapting along the way.

The leader is responsible to ensure that the business invested in has a real business or community (if a non-profit) purpose. This means: being realistic about not throwing good money after bad; separating real, business activity from ego gratification; and assuring at least a baseline of security by taking prudent risks.
The leader is responsible to the people who work in the business. This involves: establishing organizational goals; providing direction about employees’ responsibilities in meeting these goals; setting standards of performance; and providing job performance feedback. Organizing work in this way frees employees to perform effectively because it assures them that their positions are not held capriciously at the whim of the leader and that their paychecks are not constantly in jeopardy. Taking this approach also facilitates identifying organizational successes and potential roadblocks. In a world of rapid change, a little perceived security goes a long way.

Finally, the leader is responsible to him- or herself, his/her family and other stakeholders to do succession planning. Timely, thorough (and flexible) succession planning can facilitate a smooth transition when the leader determines that: the business is no longer viable; s/he has personally had enough of it; or, it has just become time to step aside.

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Your exit strategy/succession plan is vital to your future, so I’ll be posting the views of others from time to time and keeping them current as I find them.  If you know of an article that should be here, send it in and if the author is agreeable, I’ll post a link to that piece as well.  The intent is to help best inform you on the important decisions surrounding your moving on, or moving out.

Happy reading:

RESOURCES

1.  From David Stember
http://www.bizinvermont.com/biz_in_vermont-blog/2009/7/28/succession-planning-a-process-not-an-event.html

2. http://www.bizinvermont.com/biz_in_vermont-blog/2009/7/10/exit-strategy-planning-from-overwhelm-to-completion.html

3. From Tim Berry  http://bplans.typepad.com/blog/2008/01/how-our-success.html

John Reddish, the Succession Planner & Get Results Coach

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• If the company is sold, you are less encumbered by employment/consulting agreements, appearances for the company, long covenants not to compete, etc.;
• If the company is not sold, but annuitized, you get the same benefits as above, but without some of the restrictions, but you may also have some risk exposure still;
• If you suddenly find time on your hands, and have been complaining, “if only I had time to…” you will now be one fewer excuse away from actually doing…;
• Having time on your hands will reap unexpected opportunities to explore yourself and your world.  Not having to be at your desk forces you to be somewhere else, see other things, and that alone changes something, if not everything;
• Your successors and all your employees will become more self reliant, so if you get sick or disabled, you and your estate will be less at risk;
• Your successors, in particular, will probably come to appreciate you much more as the “buck” will be stopping on their doorstep; and,
• You may find out that YOU, while a comfortable old suit, needs a rest, while you get to see your company take on new life and new possibilities.

John Reddish, and his Associates at Advent, help entrepreneurs and other leaders who want to master growth, transition and succession to get results faster, less painfully and in ways that work for them. This happens through consulting, coaching/mentoring, training and/or speaking. Understanding that there is no ONE path to get results, client services are tailored to the way s/he can best use our services.

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Don't Let your Busines Fears Make you Feel Invisible

Studies I read and my own experience tell me the same thing – fewer than half of all companies have ownership succession plans. It happens in some very large companies and it happens in most small businesses. And, in fact, some business succession plans that exist are merely print exercises to allay the fears of share- and stake-holders, with the leader having no real intention to, or desire for, stepping down.

Is it fear of planning? Is it fear that by identifying successors in advance, they may try to force the leader out prematurely? Is developing an exit strategy merely a low priority?

Thirty years in the business tells me succession planning’s greatest inhibitor is the leader’s fear of becoming invisible – irrelevant! Not wanting to go – ever – is part of it. For many leaders, particularly founders, the entity (profit or nonprofit) is psychologically tied to their own self-worth. I feel this same fear in my small company – I want to do this forever, and know I can’t.

So many of us put succession off. We tell ourselves it won’t happen to us – YET! We tell ourselves, and our possible successors, they aren’t yet ready to assume control. We turn a blind eye to the importance of who, and what, comes next. WE know next, counts, but that’s for tomorrow.

Some of us have no plan for tomorrow and so the fear rises to the level of terror. What would we do if we didn’t come in to work?

I have a friend who I helped forge a second career as a professional director after his “corporate” days were done. His post-work plan called for serving on a few boards, playing tennis (and, as I recall, golf), traveling with his wife and family, kicking back a little and just savoring life. Two years into his plan, he was busier than ever with his board work, his games still wanting love and birdies, kicking back was not yet on the calendar, but, he was spending more quality time with his wife and family.

Like many Boomers, I struggle with the fear of becoming invisible, irrelevant. But I know that fear is like the childhood fear of monsters in the bedroom, I know better. I feel it, but I know better, and try to help others because if our ideas, our businesses, our legacies are to survive and prosper, it is a fear we must all overcome.

Is this fear standing in the way of a crafting a succession plan that works for you?

(C) 2009 John J Reddish

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There are two components of an adequate return: time invested must be compensated through salary, benefits and perks; AND, money invested must be guaranteed a fair rate of return plus a premium for the level of risk assumed.  Adequate returns do not just happen, they are achieved through planning and action.  This commitment involves setting realistic, quantifiable goals; taking the steps necessary to attain the goals; measuring the results; and, adapting along the way.

The leader is responsible to ensure that the business invested in has a real business or community (if a non-profit) purpose.  This means: being realistic about not throwing good money after bad; separating real, business activity from ego gratification; and assuring at least a baseline of security by taking prudent risks.

The leader is responsible to the people who work in the business. This involves: establishing organizational goals; providing direction about employees’ responsibilities in meeting these goals; setting standards of performance; and providing job performance feedback.  This organized approach frees employees to perform effectively because it assures them that their positions are not held capriciously at the whim of the leader and that their paychecks are not constantly in jeopardy.  This approach also facilitates identifying organizational successes and potential roadblocks.  In a world of rapid change, a little perceived security goes a long way.

Finally, the leader is responsible to him- or herself, family and other stakeholders to do succession planning.  Timely, thorough succession planning can facilitate a smooth transition when the leader determines that: the business is no longer viable; s/he has personally had enough of it; or, it has just become time to step aside.

If you have truly lost your passion, it’s time to go.  Following are steps to take to protect yourself and your estate as you go.

Check out this earlier post for part 2 of this post “Your Walk Away Checklist:” http://www.thesuccessionplanner.com/exit-strategies/crafting-your-business-succession-plan-and-strategies-my-top-18-tips-to-your-successful-business-sale/2008/11

Part 3 of this post to come later in the week

© 2005, 2009 By John J. Reddish, CMC

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I did several press interviews during that scandal.  During the interviews, I pointed out that virtually all endorsement contracts contain a “morals” provision, stating that scandalous behavior on the part of the celebrity could result in immediate termination of his/her contract.  I also noted that “Bad boy/girl” celebrities can act badly and hardly impact their endorsement contracts at all, but if you present yourself as one the “good guys/girls” you have to live up to your good reputation, or else.

From a business succession perspective – understanding the importance of who/what comes next – anyone seeking or holding endorsement or sponsorship contracts should think long and hard about behaving badly.  It’s not just a matter of doing what’s right, we’d all argue in favor of that.  It is also a matter of protecting the “goose” that lays golden eggs.  Kobe Bryant was on the way to becoming a superstar in the endorsement arena.  Michael Phelps has been on a similar track.  Both derailed.  How badly is still unfolding.

In Phelps defense, smoking marijuana is far less troubling than committing adultery.  Furthermore, his 2004 underage drinking incident has not been repeated.  Still, I believe he is literally on the brink.  Some sponsors have not renewed (according to the Associated Press, Rosetta Stone, AT&T and PowerBar have ended their relationship with Phelps).  Some are supportive (notably Hilton Hotels, Speedo and Pure Sport).  Others (VISA, Kellogg, Subway and 505 Games), have yet to speak out (some sponsors choose to let contracts expire quietly rather than take a public stand).

To an advertiser, particularly a consumer products company, even the hint of scandal can tilt sales downward, particularly when parents as well as their children are controlling the spending.  In a recessionary period it

might not take much to say, “Goodbye, Michael.”  If Michael Phelps gets back on track, he’ll still make millions, but one night’s high has certainly lowered his prospects.  Another incident and it could be even more costly.

There is always a “next.”  Understanding the importance of, and knowing how to prosper from the transition is what succession planning is all about.
John Reddish speaks to and works with entrepreneurs and leaders who want to master growth, transition and succession to get results faster, less painfully and in ways that work for them.  Contact John at: 610.506.6311 or e-mail to: Johnr [at] getresults [dot] com.

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Fred, a Yale grad who went on to do some of the best work (in my opinion) done in the late 20^th century in the area of corporate innovation (as founder and president of the Strategic Innovation Inc.), was a constant source of new ideas and a wonderful story teller.  He loved his work and it showed.  He also has a wicked sense of humor, once telling a joke about cats at a client meeting that I forbade him from ever telling again.

I first met Fred when I was Vice President of Special Programs at the Presidents Association of AMA and he came to me to propose a workshop for CEO’s and Company Presidents on his Innovation Process.  Later, when I left AMA, we became associated and were involved in a number of projects over the years.  Even when not actively working together, we maintained an active correspondence, sharing jokes and new product development ideas.

I will miss Fred’s smiling face, quick wit and thoughtful collaboration.  And I will remember him, as well, for the gifts he shared, for times spent together and from the learning he graciously shared.  Goodbye, Fred, thanks for the memories.

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