SUCCESSION PLANNING
The jigsaw puzzle
of succession planning

Five keys to preventing a disaster

BY MIKE COHN

Succession planning is a tough process because it never ends. Just when you think it’s finally finished, some unexpected event forces you to rethink the whole thing.

An unanticipated buyer. A divorce. Or your sudden recognizing, as did Wang Labs, Schwinn bicycles, Lear Jets and Steinway piano, that your chosen successors may not have what it takes. Then it’s back to the drawing board.

Some chiefs of family companies mistakenly confuse succession planning with estate planning. That’s a dangerous mistake. Your will and trusts may be in great shape while your company’s succession plan may be a disaster waiting to happen. How do you know when you’ve covered all the bases?

A good succession plan will address five basic issues:

Business opportunities and risks. A strategic assessment will help you determine if you should keep or sell the business. Look at the current value of the business, at methods needed to improve business value, and at any factor that might potentially reduce its value.

The assessment should address your current capital needs: Are they sufficient to meet future requirements? Will there be possible conflicts, such as a need to reinvest in the business while paying off withdrawing shareholders? When you evaluate your capital needs, don’t overlook the intellectual capital you need in your advisers and key people. How will your business differentiate itself from consolidators and remain competitive? Who is your future competition, and are your successors preparing for that challenge today?

Generational differences between the way the current generation runs the business and how the next generation may run it. Many family businesses need to evolve from “family-first” type companies to “business-first” organizations. In a “family-first” type company, decisions are driven by the need to solve family needs first while the company’s needs come second. One example would be the inability to say “no” to family members who demand higher pay to support their expensive lifestyle.

Another example would be anointing the next generation leader based on seniority and loyalty instead of accomplishments. For example, even though Steve Forbes, has competently run Forbes magazine, he was raised by his late father, Malcom, to assume the post, based on his birth order.

Many companies also need to change from an entrepreneurial management style to a more professional style. That doesn’t mean becoming a bureaucracy; it means staying focused, fast and entrepreneurial while pushing decision-making and accountabilities down into the organization. The skills required for the next CEO may be quite different than what has worked for the current CEO.

Ownership models. First-eneration companies tend to use an owner-manager model of ownership: The owners work in the business and derive their “ownership benefits” from compensation and other deductible perks.

Second- and third-generation companies are often sibling- or cousin-owned and use a hybrid ownership model with some family active in the business and some not active but involved as owners. Newsletter publisher Kiplinger's, for example, is owned by 16 extended family shareholders, although only three members of the family are actively involved in running the company.

Different voting rights may be used to vest operational control in the hands of the active owners while preserving “big” decisions for all shareholders. Shareholder agreements can provide options so inactive relatives have opportunities to sell stock during their lifetime, preferably to their active relatives.

As companies evolve, an owner-investor model may be used, with ownership held in family entities such as family limited partnerships (for C corporations) or trusts (to hold S corporation stock). Governance policies with the owner-investor model usually include a more active board.

The owner-investor model may hire non-family to run the business while the family pursues different career paths but retains ownership. Understanding ownership options is important, because many family businesses follow historical precedents (“This is the way Dad did it”) in their planning instead of thinking strategically. Having patient family members leave their equity in the business is one way to build capital.

Leadership and management. Is there a shared vision for the business? If so, who in the next generation possesses the passion and competence to implement it? Should the next generation let non-family run the company? What kinds of incentives (stock options, shadow stock, appreciation rights) will you need in your private company to attract and retain top people?

Your successors may know their jobs, but do they know the company? How much time does the current CEO spend consciously cultivating leadership? If he spends less than 20%, there’s a problem. Does the next generation of owners enjoy the trust and respect of the company’s long-term key execs? Have successors developed the strategic thinking skills needed to succeed in the future?

One thing is certain: Future leaders will spend more time on communication and relationship issues than in the past. So how does your heir-apparent stack up? The competencies of the next generation need to be aligned with the company’s needs. Do you have the top team you need? And if not, do you have the time and heart to build it?

Personal/family issues. These are emotional as well as financial. Here is where you address the fairness/equalization issues when some children are active in the business and some are not.

These questions may get solved in the estate plan or in some other manner—for example, buybacks of gifted stock. Issues of financial independence (for the current generation) also need to be addressed. If the senior generation relies on continued income from the business, how will that reliance be resolved (and securitized) in the succession plan? When will the current owner-manager let go, and what does she have to let go toward?

Dealing with change of control issues (to the next generation) is often difficult. Can the current CEO fire himself, and perhaps become chairman? Or does he need (for the sake of the business) to withdraw entirely from the company?

The primary requirements to maintain ownership of a family business are: patient capital and long-term thinking, a willingness to manage risk, a realistic view of the external forces facing the company, skilled management of your internal resources, a balanced tension between the family culture and bottom-line results, and finally, a willingness to communicate and share information with stakeholders.

That’s a tall order. Measure your own progress in developing your succession plan, and begin to address areas where attention may be needed.