SUCCESSION PLANNING
Keep your banker in the loop

You have a relationship with your banker. Do your successors?

BY MIKE COHN

Quick: What would your bank do if something happened to the current CEO/chairman of your company?

Here’s a common scenario: you have worked hard to build the retained earnings of your company to $10 million. Your banker has worked with you and your controller/CFO and your borrowing capacity is now at $15 million which includes a term loan of $5 million, and a corporate line of $10 million. There are no personal guarantees on the bank loans.

The next generation is “coming along” and the plan is for your son to become president in a few years with you becoming chairman. The problem is that nobody knows the plan except you, your son, maybe your controller/CFO, and possibly your and your son’s spouses.

Typical bank covenants require maintenance of financial ratios including cash flow coverage, maximum debt to equity ratios and other requirements that you and your controller/CFO have hammered out with your banker over time.

Here’s how your banker might look at this scenario: Your company has a capital base of $25 million. The bank has put up 60% ($15 million) of that amount and you have put up 40% ($10 million). The bank knows you (the CEO) and the controller/CFO but no one else.

The banker views his role with you as a financial "partner"—remaining silent as long as things go well, but with the ability to be not-so-silent. They like the way you operate because you have generally met your projections and you have told them in advance when business was turning downward. They have learned to trust you. The bank maintains they are a “relationship” lender. What that might mean is that if there isn’t a relationship they may not be a lender.

Let's assume you and your son are pleased with the progress he is making in the company. He is gaining respect from various key people, has implemented some procedures that are working and is beginning to understand what the company needs in the future to continue its growth. It's time to include him (or her) in meetings with the bank.

What the bank wants is a written plan (or even a simple memo) that says if something happens to Dad, or the current CEO/Chairman, here is who will run the business. A management succession plan describes who would do what if the current CEO was not available; it is intended to prevent the bank from getting nervous about the lines of credit.

The worst thing to happen in the event of an unexpected illness or accident, while the next generation is figuring out what to do, is the bank getting nervous about its relationship with your company. You don’t want to be telling the bank that everything is fine from your hospital bed.

Here is what should be in a management succession memo for the bank:

Who will act as President? What experience do they have? Provide a bio including education, positions held in the company, how well they know the industry and what their accomplishments have been to date.

• How will reporting relationships change? Will key execs take on added responsibilities?
• Is there a Board, or will a Board spring into being to advise the “new” CEO? Who is on the Board?
• Will your spouse have a role? If yes, what will it be?
• Will the business need to continue income to a disabled owner or deceased owner’s spouse? How much? And for how long? Will those obligations impact any of the financial ratios or cause the company to be out of compliance with any of its covenants?
• Will buyouts be triggered due to death or disability? Are these agreements funded with insurance or will bank lines be tapped? Will the bank agree to draws on the line to buyout a deceased or disabled stockholder?

These are tough issues to contemplate but if you don’t take the initiative early on, your bank certainly will—and usually at the worst time possible.

Bankers are the first to admit they don’t like surprises. Include them in your thinking about management succession so they can begin to ask questions about the next generation’s capabilities. Include the next generation in meetings with the bank.

Are there existing covenants you need to address now with your bank? For example, a requirement for retaining current management could be expanded to include next generation successors. Or, if there are formulas defining the amount of compensation, including rents and bonuses you can draw, try to have that provision liberalized in the event of a disability or accident.

From a successor’s standpoint, knowing the covenants you are required to maintain provides them with an important way to understand the financial statements. The more knowledgeable your successor becomes about the financials, the better they can communicate with the bank and gain respect for themselves.

You can’t do anything about unexpected illnesses or accidents but you can mitigate some of the consequences by keeping your financial partner informed about your plans for management and ownership succession.