Home » Plan succession sooner rather than later

Plan succession sooner rather than later

By Katheran Wasson

According to a Harvard Business Review report, 4 million businesses could change hands in the next 20 years - 75 percent don't have an exit plan.
According to a Harvard Business Review report, 4 million businesses could change hands in the next 20 years – 75 percent don’t have an exit plan.

A major transformation in business ownership is taking place in America, as baby boomers – 10,000 per day, by some estimates – reach retirement age. A Harvard Business Review report predicts 4 million businesses could change hands in the next 20 years because of it.

That’s a welcome statistic for entrepreneurs looking forward to much-deserved retirement. It’s also good news for financial advisers now providing succession planning advice to a growing number of boomer entrepreneurs. According to that same HBR report, 75 percent don’t yet have an exit plan.

“It clearly is a growing part of our business,” said Andrew McKay, head of investment banking for Kentucky-based Hilliard Lyons. “In the five years I’ve been with the firm, I’ve seen it increase every year.”

Randy Collins, Wealth Management Adviser, Northwestern Mutual
Randy Collins, Wealth Management Adviser, Northwestern Mutual

Randy Collins, a wealth management adviser with Northwestern Mutual, started working as a financial adviser in the early ’80s. Clients were mostly young professionals just starting out, trying to establish themselves financially.

The ones who succeeded are now in their 50s and 60s, and they make up a large portion of Collins’ client base. Some are entrepreneurs with an eye on retirement, which often means selling their businesses to fund their golden years.

“The people who are in the best position to do that started the thought process 20 years ago,” Collins said. “If you wait too long, you may have to default to liquidation or taking less for your business than you want or need.”

Getting started with the finish

At a minimum, McKay suggests that business owners start building a succession plan three years out. Ideally, that number would be more like five to eight years, he said, but many entrepreneurs are so busy with the day-to-day tasks of running a business, they put off the process.

But proactive succession planning can lead to higher business valuations, a path to retirement and peace of mind, McKay said.

Andrew McKay, Senior Vice President & Director  of Investment Banking, Hilliard Lyons
Andrew McKay, Senior Vice President &   Director of Investment Banking, Hilliard Lyons

“Early planning is really important,” he said. “There are things you need to think about doing with respect to making the business more attractive to potential buyers, or if you’re wanting to pass your business down to your children, you need to make sure they are ready to take over and run it.”

One client who runs a construction company is following a 10-year plan to transition ownership to his two sons, who are around age 30. That means setting aside enough time to give his sons broad experience in all areas of the business and transition customer relationships to them. Plus he needs to consider his own retirement and estate planning, McKay said.

Clients are advised how they can make their business more attractive to potential buyers, he said, from the simple, such as tidying up the office, to complexities like documenting relationships, organizing the maze of corporate records and getting rid of bad employees who should have gone long ago.

“It can be a very complicated process and can take some time,” McKay said. “If you can understand what the value of the business is and what drives your value, that’s critical. If you know what drives your value, you have time to affect it.”

That can be difficult for those who own small businesses, Collins said. Most companies in America – and certainly in Kentucky – are small and closely held. In Lexington, for example, 94 percent of businesses have fewer than 20 employees, according to U.S. Census data via the Community and Economic Development Initiative of Kentucky.

“Many of these businesses don’t have a true market value, unless they’re sold to the next generation, employees or competitors,” Collins said.

Owner emotions run high

Some clients are focused on getting top dollar for their business, McKay said. For many others, though, legacy is important. They want to know that their customers and employees will be taken care of, that the business continues to run the way they intended. That often means passing the company down to the next generation, a business partner or group of employees.

According to Hilliard Lyons, 50 percent of entrepreneurs want to pass their business down to a family member, but complications mean only one in three actually do. For the rest, selling to a third party is the eventual result.

“There’s definitely an emotional and personal component to succession planning, and then you add the complications of family relationships,” McKay said. “If you think of how complicated Thanksgiving can be, just imagine what can happen when you’re passing down the family business.”

To succeed, choosing the right people to take over is key, Collins said. Soon after, it’s time to begin handing over responsibility and authority. When entrepreneurs don’t let go of the reins, it can kill initiative in the next generation, he said.

“It’s difficult, because founders identify with what they’ve done, and they’ve fought tooth and nail to succeed,” he said. “How do you walk away from that? To me that’s the single biggest issue: the willingness to let go. It’s a dance, and some people do it well, but most people don’t. That’s why most businesses don’t make it into the next generation.”

Collins’ advises these entrepreneurs to take an honest look at their staffs. Identify a cadre of people who, if everything disappeared tomorrow, could rebuild the business, he said.

“Those key people are the ones you have to focus on,” he said. “That’s your succession plan, in one form or another. If you have a group of people you think have the potential to step up and run things when you’re gone, you need to communicate that to them, and someone will emerge as the leader of the group.”

Common mistakes

McKay identifies four primary mistakes that retiring business owners make. At the top of the list is waiting too long, which can put entrepreneurs at risk of selling their business for less than they expected.

“The most successful exits at the highest valuations tend to occur during periods of high growth valuation premiums,” McKay said. “Unfortunately, many business owners begin to consider an exit after the expansion period has passed or, worse, business is in decline.”

Starting early also gives business owners the ability to strike while the market is hot. These entrepreneurs “are more likely to recognize a strong market as an excellent time to transaction value,” he said.

Second is waiting until someone expresses interest in buying their business. This passive approach means the buyer has no pressure to move quickly, and may make a lower bid with less favorable terms. Business owners can avoid this through a competitive process, considering multiple bids confidentially until a winning bid is accepted.

Third on the list is neglecting to engage professional advisers. McKay suggests a succession planning team made up of an attorney, CPA and financial adviser to get the process started; additional professionals may also be needed, depending on the nature of the business.

Lastly, entrepreneurs often struggle to delegate authority. This is risky and can negatively affect the valuation of the business. Owners thinking about succession should begin, he said, by identifying a team of people who could run the business in their absence.

Keeping it in the family

Kathleen Hoye, Executive Director, University  of Louisville Family Business Center
Kathleen Hoye, Executive Director, University of Louisville Family Business Center

The University of Louisville Family Business Center counsels entrepreneurs and their successors as they transition family businesses to the next generation. Its membership has increased in recent years as baby boomers reach retirement age, executive director Kathleen Hoye said.

Since there’s no end in sight to demand for such services, Hoye also recently earned a certificate in exit planning.

“There’s a tsunami coming,” she said. “The baby boomers have had fewer kids than previous generations, so the pool of family candidates to take over their businesses is shrinking. People are also more mobile now, so family isn’t always nearby.”

As such, Hoye said baby boomer entrepreneurs need to consider all their exit options – not just keeping it in the family.

“You never want to preclude a third-party sale, so you want to consider that,” she said, likening the situation to owning a home.

“You may want to live in your house the rest of your life and pass it down to your grandkids, but you also want to position the house so you can sell it at any time for maximum value,” she said. “It’s the same with a family business. You want to understand what those value drivers are and keep focusing on them because you may get an offer you can’t refuse, or you may run into roadblocks with your family.”

It’s important to have a conversation early in the planning process to decide under what conditions the family would sell the business. She recommends hiring a facilitator to aid the discussion.

“It can feel very strange to have those kinds of conversations with your family, but a facilitator can get the conversation going and the wheels turning and help you develop new ways of communicating,” she said.

Hoye said succession planning can often take five to 15 years, so it’s never too early to start thinking about it. She suggests entrepreneurs ask themselves three questions to get things going:

• When do I want to leave the business?

• To whom to I want to transfer the business?

• How much money do I need to retire, and where will those funds come from?

“It’s the greatest test of leadership to be able to transition, in a planned way, and make those tough decisions and then step away, delegate and retire,” Hoye said. “Some people hope their families will just sort it out after they die, but that’s the reason so few family businesses survive.”

That means asking now if any family members are interested in taking over and posing some even tougher questions, too.

For example, Hoye said, will only family members be allowed ownership? If so, how will the company define “family” – does it include stepchildren and spouses? Will jobs be created for family members, or will they have to apply for them like anyone else? What are the rights and responsibilities of the new owners?

Families looking to transition must figure out the answers and write them down, she said. Hoye recommends creating a family council and board of directors so family dynamics don’t drive business strategy.

She advises that entrepreneurs join a family business center – they’re located across the country – and get both generations involved in the process. They’ll learn best practices for succession planning and common pitfalls that can be avoided with a little education.

“Succession planning is not a product or an event,” she said. “It’s a process, and it requires a ton of communication, so the best thing to do is start with your own family and start to have the conversation.”

Unique challenges on the farm

The baby boomer retirement shift isn’t just affecting brick-and-mortar businesses – farms, too, are feeling the effects. The average age of principal farm operators in Kentucky is nearly 58, according to the 2012 USDA Census of Agriculture. With more than 77,000 farms statewide, that has the potential to make a big impact as these farm owners continue to age out of the business.

The Legacy Project, a national effort by Farm Journal to promote succession planning among farmers, offers step-by-step plans for farm families wishing to start the process. Only 10 percent of farms make it to the third generation, and the project aims to help farmers beat those odds.

Dick Wittman, Farm Management Consultant and Columnist, Legacy Project

Experts suggest starting with a family meeting to discuss the farm’s future. Dick Wittman, a farm management consultant and columnist for the Legacy Project, says farm owners must determine if there are any suitable successors. If not, they may need to consider liquidation or leasing the property to ensure their own financial security into retirement.

Wittman recommends putting succession plans in writing to make expectations clear for all involved, and determining organizational structure up front. As in any other business, the most successful successors are those with leadership and management skills – and that’s not always the firstborn son, he said.

The Legacy Project suggests updating those written plans annually. Changes in family structure, the business – even tax laws – can have an impact on farm succession planning.

The right time doesn’t just happen

Even for entrepreneurs who get started early with succession planning, actually stepping away from the business can be a challenge. Whereas most people think of retirement as a specific age or date that they plan to clock out for the last time, Collins said, “It’s rare that someone who started a business ever thinks of it that way.”

“They may have ideas about when they’d like to step back and not work as hard, but walking away entirely is difficult for many entrepreneurs,” he said. “You have to build a structure to do that, and for many people, it’s easier in the short term to just do the work themselves rather than train someone else to take over the business.”

Many entrepreneurs neglect to build nest eggs aside from their businesses, and very few owners sell for a windfall lump sum payment, Collins said.

“If there’s anything that allows a business owner to quantify a date and stick to it, it’s that they build wealth as they go along so they aren’t depending on the business to retire,” he said.

That, he says is a cautionary tale for millennials – a group that is even larger than the baby boomer cohort. Collins said while time might be running out for one generation to plan for retirement, another can still make a real difference in their futures.

“I would tell today’s 20- and 30-year-olds to look at your parents, and whatever decisions you make for your future, think about the decisions they’re having to make now,” he said. “You’ve never had a better reflective group than you have right now.”