Strategic Succession: Taking Steps to Secure Your Business's Future – Part 1

Business succession plans are a necessary step to protect your family business. The most obvious benefits of business succession planning include avoiding potential family conflict, and preserving the family business for future generations. Despite the obvious benefits, less than a quarter of all family businesses have a formal succession plan. As a result, seventy percent of family owned businesses do not survive into the second generation, and eighty-five percent do not survive into the third generation. Building a plan as early as possible is crucial, however it is never too late to begin planning.

A business succession plan is a formal business plan used to determine how a business’s assets and management positions will be passed to the successor. A plan of succession ensures the family business can continue without significant disruption in the event of a family member’s death or retirement. Over the next four articles, we will explore several topics relating to business succession planning, including how to choose the right successor(s), the importance of developing sound management structures and processes, structuring the transition and finally, incorporating the transition into the owner’s estate plan.

Step One. Selecting and Preparing the Successors

The first step in implementing a business succession plan is to determine who the successors should be. Many owners of family businesses want their children to take over the family business, and assume the children will want to and will be qualified to do so. To successfully accomplish such a transition requires careful planning and oftentimes, hard conversations. The owner must determine whether the children want to take over the business. Unspoken assumptions can lead to situations where children feel forced to take over a business they are not passionate about, or situations where the children stick it out until they finally reach a breaking point and simply walk away.

Assuming the children are willing and interested in taking over the business, the owner must also determine whether the children are qualified to run the business. If they are not yet qualified, management training should be implemented and they should be put in positions where they can grow and develop the skills they will need. Importantly, this often will require the owner to not intervene in situations where the owner would have handled a matter differently. The owner may want to consider hiring outside consultants or advisors to help evaluate the strengths and weaknesses of family members to avoid any biases and provide the required training and evaluation. Guidance from outside advisors is generally better received than critique from family members and additionally, this helps protect family relationships. Once those strengths and weaknesses are assessed, the owner should work to fill in the gaps with other key employees. These key employees could be included in the ownership team, but at a minimum incentive compensation arrangements and restrictive covenants should be implemented.  

Once the owner has determined who the successor owners will be, and taken steps to prepare them to take over, the next area of focus will be on developing a formalized management structure for the business, which we’ll address in the next article.

Step 2. Developing Sound Management Structure and Processes.

Whether a succession plan involves passing ownership to family members, or selling to key employees, it is also important to implement processes and management structures to insure a successful transaction.

Developing a management structure starts with developing an organizational chart. When a business is started, the owner typically wears all the hats. New positions may be created and filled based on what the owner least likes to do, or what he or she feels most uncomfortable doing. Roles are often not well defined as everyone pitches in as needed to make sure the job gets done and the business keeps cranking. This often results in opaquely defined duties, overlap and gaps in responsibilities, frustration and confusion among the employees and management. That confusion needs to be cleared in order for a business to successfully transition. The owner needs to identify the seats that need to be filled, who will fill those seats and, in some cases, who may no longer have a seat.

Another important component is the development of the management structure. The owner should identify an executive team that will report to the owner (and eventually may succeed to the ownership role). The owner will also need to decide how much authority the executive team will be given to make decisions. Not enough autonomy too late may create as much risk to the company as too much autonomy too soon.

A business owner may also implement an outside board of directors or advisory council. These groups often consist of peers in the business community that are willing to assist the business owner in this process, by providing advice and accountability, typically in an advisory capacity rather than fiduciary. A carefully constructed board or council can enhance the perspective of the family business allowing business successors to be chosen based on business and financial considerations rather than solely based on family connections. A board or council can also aid in identifying critical employees to the business and help guarantee those employees are retained.

Carefully protecting the goodwill of the business is another important element of succession planning. As noted previously, creating incentive compensation structures help insure that valuable talent remains with the company during a transition. The intellectual property of a business should be evaluated and, if possible, protected through patents, trademark or copyright registrations, or non-disclosure agreements. Important vendor and customer relationships should be reviewed and properly documented. Expired contracts or leases should be reviewed and updated. Processes should be formalized to ensure this goodwill remains protected going forward.  

Taking the time to define roles, implement a healthy and effective management structure and protect the goodwill of the business can help set up the business to continue thriving after a transition. If you have questions regarding that process, the attorneys at Woods Fuller can help guide you to an answer.

Contact our Business & Corporate Transactions team to learn more.