Michael Beck

Successions: Is Contingency Planning Enough?

We all know the scenario: An owner wants to retire, has someone in mind to be their successor, and needs a professional to structure the transition.

So, they contact you and you set about putting together a solid plan for their succession. You help them clarify their needs. You help them value their company. You help them structure the buyout with respect to taxes and their estate. And you help them structure the transfer of ownership.

Additionally, because you have much more experience at this than they do, you include strategies to protect them if things don’t go as planned.

Frequently, to protect the owner’s interest and the company’s value, transfer of ownership is phased in over time. This helps the owner retain control of the company as the successor takes on more and more responsibility. It also gives the successor incentive by giving him or her increasing stock ownership. This works well as long as the successor does well.

But what if the successor doesn’t do well? While it’s true that the owner still retains ownership, the reality is that – years after the transition plan was developed – they’re left with no successor and will need to either find a new successor or sell to some outsider.

An effective way to minimize the likelihood of successor failure is to have a professional help groom and guide the successor, thereby increasing the likelihood that he or she will succeed. With so much at stake, it’s a smart investment. It’s why we offer Successor Development.

Alternatively, if the owner wants to completely step away from the company upon signing the transition papers, ownership is transferred to the successor immediately and the owner takes back a promissory note that the successor will make payments on over time. A good contingency plan provides a solution in the event that the successor defaults on his or her loan payments. Typically, the owner gets the stock back and returns to run the company.

But if that happens, there are a number of serious problems that arise. One is that the owner will have to come out of retirement (after several years of being retired) to run the company once again. The second problem is that the company will no longer be as valuable as it once was (as evidenced by the poor cash flow causing the loan default). A third problem is that, just as in the previous scenario, the owner no longer has a successor.

And the last problem is that (years after the original transition) the market will have a sizable surplus of seller over buyers, resulting in a buyer’s market with lower multiples and buyers who are more demanding. (I’ve written about this in a previous article.)

Once again, an effective way to minimize the likelihood of failure is to have a professional help groom and guide the new owner, thereby increasing the likelihood that he or she will succeed. With so much at stake, it’s a smart investment. It’s also why we offer Successor Development.

Finally, even with additional guidance and grooming, the successor sometimes turns out to be a poor choice and doesn’t succeed. In that case, recruiting a new successor may be the best solution for the owner because it will provide the full value of the business and will keep the business locally/privately owned. It’s why we offer Successor Recruiting.

3 Common Mistakes a New Owner Needs to Avoid

Taking over the ownership of a company is an exciting event. It’s a time filled with hope and dreams, opportunity and vision, fear and insecurity, and broad responsibility.

Your family relies on the business doing well. Employees and their families rely on the business doing well. Customers and suppliers rely on the business doing well. Even the previous owner relies on the business doing well (if for no other reason than to ensure that all the buyout payments get made).

Because of all these things, it’s important to avoid the following three common new owner mistakes.

Mistake #1: Making Changes Simply to Prove the New Owner Is in Charge

There are two aspects to this mistake that need to be addressed. First, newly acquired power, responsibility, and authority can be intoxicating. It can be tempting to flex one’s new ownership muscles. This temptation can arise from years of having ideas without the authority to implement them or it can arise if the new owner feels he or she must establish his or her leadership competence in the eyes of employees. The second aspect pertains to the successor’s relationship with the founder. There may be a tendency to arbitrarily make changes simply to establish that he or she is now in charge, not the founder.

In either case, making changes simply for the sake of change is a mistake. A wise owner will reflect on his or her motivations for wanting a change, show restraint, and reflect good judgment before making any changes. Change for the sake of change is destined to cause problems rather than solve them.

Mistake #2: Continuing to Think (and Act) Like an Employee

In many cases, a new owner has spent his or her entire career as an employee. The mistake is to continue to think and act like an employee. There are several differences between the way an employee thinks and the way an owner thinks, and if a new owner doesn’t make this shift, problems will arise.

Employees tend to think narrowly. They usually focus on the task at hand and/or on their specific domain of responsibility (operations, finance, engineering, etc.). In contrast, an owner needs to consider the bigger picture and how his or her decisions impact each aspect of the business.

Employees tend to think short-term. Their focus tends to be on current matters, current revenues, current expenses, and current profits. In contrast, an owner needs to consider both short-term and long-term success, needs to be able to make decisions without having all of the information about the future, and must learn to balance risk and reward. Rarely is a decision about the future risk-free, and an owner needs the ability to assess and minimize that risk.

Additionally, employees tend to focus on doing good work while at work but generally don’t take their work home with them. Owners, on the other hand, learn that the business becomes their life, and they think about it all the time, wherever they are.

And finally, employees know that if they make poor decisions, or they become dissatisfied, or the business just doesn’t do well, they can always find a new job elsewhere. Owners understand that failure is not an option. Generally, there is no “Plan B.” They understand that the business is their only future, and this understanding colors their decisions and actions.

Mistake #3: Not Earning the Trust and Respect of Others

The degree to which an owner earns the trust and respect of others determines the effectiveness of their leadership. There’s a big difference between the results gained from people who simply comply with orders and those gained from people who are committed to the success of the company. Exceptional leadership elicits excellence. In order for an owner to be effective, he or she must earn the trust and respect of those around them. A new title doesn’t automatically earn the trust and respect of others. Industry knowledge can earn professional respect, but a leader earns trust and respect through everyday actions.

Trust is earned by demonstrating integrity. It is critical for an owner to follow through on his or her commitments. Actions truly do speak louder than words, and good intentions won’t cut it. Owners may have the best intentions when they agree to a list of commitments, but if they don’t follow through on those commitments, they’re viewed as lacking integrity. Likewise, if an owner states that certain values are important to him or her but then acts in a manner at odds with those values, they demonstrate a lack of integrity. And when that happens, people learn not to trust them.

Respect must also be earned. The most effective way to earn respect from people is to show them respect. As leaders, we show respect when we listen to what others have to say. People often feel they have good ideas and have something to contribute. Whether we agree with them or not, soliciting input from others demonstrates that we value them and their ideas, and that goes towards earning their respect. The most effective means of showing respect for others is asking good questions of people and then listening to their answers.

How to Avoid These Mistakes

It’s often difficult for new owners to bridge the gap between where they are and where they need to be. And bridging that gap can be the difference between a successful business and one that languishes in mediocrity. However, an owner’s ability to evolve generally relies on two things.

Having a Confidential Sounding Board
Often, the evolution of a company is conceived during open discussion of ideas, but most owners don’t have the right “sounding board”. It requires an environment within which an owner’s inklings, ideas, and concerns are brought to light, challenged, and expanded. The best strategies will leverage strengths, minimize risk, and balance long-term needs and goals with short-term needs and goals.

Gaining Unbiased, Outside Perspective
Outside perspective is essential as a catalyst for creative, game-changing strategic thought. Outside input is necessary to uncover blind spots and move past them. Every owner needs an objective, supportive confidant with whom to complain, vent, confide in, and talk things out. Owners must carefully think through possibilities, assess and manage risk, and then select the strategic plans with the best potential.

If you’d like help as a new owner, please give us a call. Our team of executive coaches works with clients around North America. Executive coaching can help an owner grow revenues, increase profits, and improve cash flow. You are welcome to call me on my direct office line: Michael Beck, 503-928-7645 (Portland, OR).

The Cost of Inaction

Many owners (if not most) wait until they’re ready to retire before they get serious about the planning of a transition. That timeframe is usually about 6 months before they want to sell the business. And while it’s true that most deals can be completed within 6 months, getting a deal done and getting the price and terms you want can be very different things.

There’s a cost to waiting until the last minute to plan an exit.

EXTERNAL SALES

Typically, when an owner plans to sell his or her company to an outside buyer, they’ve imagined a scenario where an advisor reviews their company, puts a value on it (which ends up being equal to what the owner feels it’s worth), and goes about finding a buyer. Once the buyer is found, they come in, look over the books and the operations, and write the owner a check for the value of the business in exchange for the keys.

But it rarely works like that…

More often, one or more issues related to price or terms surfaces and can even derail the plan.

Value Less Than Desired
When a formal valuation is done, sometimes the value is higher than expected, but often it is lower. Transition experts can help an owner increase the value of their company, but it takes time. Once changes are made and the improvements generate greater growth and profitability, that increased performance needs to be demonstrated for at least a year or more to properly boost the value of the business.

If an owner waits to address this, he or she will be forced to accept a lower value. There is a cost to inaction.

Actions to Take and The Benefits:
There are several steps an owner should take a year or more in advance of a sale to avoid surprises and to maximize value. A formal business valuation should be conducted to establish an unbiased value for the business. In addition, a preliminary Quality of Earnings evaluation and a Quality of Leadership assessment should be done to uncover any potential issues that could negatively impact value. Once the valuation, Quality of Earnings and Quality of Leadership are done, any shortcomings can then be addressed to mitigate problems and maximize value.

Price Less Than Desired
Generally, the price a buyer will pay for a company is close to the formal valuation figure. And that price is often a multiple of EBITDA. But as the wave of Boomer-owner retirements builds (it started in 2021), there will be a growing surplus of businesses on the market looking for a buyer. And with a growing surplus comes falling multiples. In other words, where the price might have been 6 times EBITDA, it may well drop to 4 times EBITDA.

If an owner waits too long to sell the company, he or she will be forced to accept a lower price due to the surplus of sellers on the market. There is a cost to inaction.

Actions to Take and The Benefits:
The Boomer owner retirement wave has begun (2021), the surplus of sellers over buyers will consistently increase over the next 3-4 years, and the surplus will persist for another 8-10 years after that. Given the dynamics of the marketplace, the best way to ensure a high multiple (and therefore a strong price), is to put an exit plan into action sooner than later.

Less Desirable Terms
Another consequence of a growing surplus of sellers, is that buyers can become more demanding and may require terms that an owner may find undesirable. They may demand a significant earn-out, where the owner must “earn” part of the purchase price based on the performance of the business following the acquisition. Or buyers may demand that the owner stay on for an extended period (1-3 years) to ensure performance. Or there may be any number of other demands that the owner may not like, which could be deal breakers.

If an owner waits too long to sell the company, he or she will be forced to accept additional terms because they’ve lost their leverage due to the surplus. There is a cost to inaction.

Actions to Take and The Benefits:
The same advice to maximize multiples holds true for deal terms. The sooner an owner acts, the more leverage he or she will have over the terms of the deal.

INTERNAL SALES

Just as with an external sale, an owner who plans on having a successor take over has also imagined a scenario. They imagine that when the time comes to retire, their chosen successor will be ready and willing to take the reins of the company and will successfully lead it into the future. The business will continue to grow, profits will continue to grow, employees will be happy, customers will be happy, and of course, all the buyout payments will be made.

But it doesn’t always happen like that…

Choosing the right person and properly preparing them to take over is essential to the success of an internal sale (succession). But many times, one or more issues exist and – if not addressed in advance – can cause major problems. There is a cost to inaction.

Lack of Preparedness
Preparing someone to take over the business is essential to the success of an internal sale. But grooming them in the mechanics of the business does not necessarily develop their ability to lead effectively, their ability of think strategically, nor their ability to make good decisions.

The result of an inadequately prepared successor can be employee turnover, loss of customers, declining revenues, diminishing profits, and missed buyout payments. There is a cost to inaction.

Actions to Take and The Benefits:
It’s very difficult for an owner to be objective about their successor. Therefore, it is essential to the success of a successor that an objective assessment be conducted and they get outside, objective coaching. It generally takes 6-12 months of coaching to develop the competencies needed for leadership and ownership success.

They’ll become a more effective leader, they’ll develop smarter strategies, and they’ll make better decisions.

Choosing the Wrong Person
Sometimes, no matter how much an owner and/or an executive coach grooms and mentors someone, they still won’t be effective at leading the company.

The problem, however, is that those shortcomings often are not evident until the successor takes over. And of course, by then it’s too late. In fact, often the shortcomings themselves aren’t apparent, but rather manifest themselves in declining business performance. Obviously, waiting until there’s no turning back is a mistake. There is a cost to inaction.

Actions to Take and The Benefits:
An objective assessment can reveal many of those shortcomings. But identifying a successor’s strengths and weaknesses is only part of what needs to happen. Having a successor work with an experienced executive coach can reveal lapses in judgment, gaps in interpersonal skills and blind spots. Usually these can be determined within about 3 months.

If it becomes apparent that the successor is the wrong person, a new successor can be recruited and groomed. The process of finding that right person can be completed in about 3-4 months. And at least another 9-12 months should be allowed to allow the successor to prove him or herself prior to the owner retiring.

Having to Choose Among Several People
When there are several potential successors, owners often put off choosing one as long as possible. They either can’t make the decision, hope that one will rise above the others, or fear the fallout that may come from one being chosen over the others.

But of course, procrastinating doesn’t resolve anything and more likely, will create even more problems and anxiety if done at the last minute. There is a cost to inaction.

Actions to Take and The Benefits:
The best way to make a decision that will be the least upsetting to people is one based on objective assessments. They will provide an unbiased picture of each person’s strengths and weaknesses. The results will allow an owner to either choose one over the others based on their strengths or split responsibilities based on their strengths. The objectivity removes a good deal of emotion from the decision process.

BOTTOM LINE

The bottom line is that, regardless of whether an owner plans to sell their company to an outside buyer or an internal buyer, waiting until months before the event usually produces less than desirable results. Taking action well in advance of a sale will either uncover issues that can be addressed (so the business is attractive to buyers), or will prove that everything is in order and will allow the owner to sleep at night, knowing their future is secure.

Why Business Owners Procrastinate (and How to Get Them to Act!)

As I network around the country, I frequently hear advisors talk about business owners who procrastinate about taking action on their transition plans. Clearly, the owners are thinking about transitioning, otherwise they wouldn’t have met with an advisor. And it seems like they’d be ready to act on their advisor’s recommendations. But often, they don’t. So, it raises the question, why do they procrastinate? Why do they avoid taking action?

The truth is that most owners procrastinate for one reason – fear.

For the most part, these fears are unspoken. And the result is that their fears cause an owner to keep “kicking the can down the road”.

The key to moving past these fears is to first uncover any unspoken fears and then to offer perspectives or solutions to address them. If you’ve ever had an owner procrastinate, you already know presenting a logical argument rarely moves someone to take action. The reason is that people “buy” emotionally, rather than logically. It doesn’t matter whether you’re selling TV’s or cars or ideas or strategies. People buy into it emotionally and then rationalize their decision logically.

The process of allaying an owner’s fears about a transition and helping them feel good about moving forward starts with uncovering those fears. Once you’ve identified the issues that are creating anxiety, you can then make suggestions to help alleviate them.

The most effective means of uncovering these unspoken fears is by asking “good” questions. A good question is one that doesn’t cause them to become defensive and gives you insights into their perspectives and their thinking. It may require you to ask a number of questions about a particular issue in order to get the insights you need to help them, but once you have those insights, you’ll be able to offer just the right perspective or solution they need.

Here are the most common fears that owners have, along with some sample questions to ask. The key is to ask questions about each of these issues to determine whether that fear exists.

GENERAL FEARS RELATED TO A TRANSITION:

>> The fear that their company won’t be worth what they had hoped for
They’re afraid of being disappointed and having to alter their retirement plans

Questions:
● What do you think your business is worth?
● How much would you like it to be worth?
● What if the value turns out to be lower?

>> The fear that they don’t know whether to sell to an outside buyer or an inside buyer and they don’t know how to make that decision

Questions:
● Would you rather sell to an outside buyer or a successor?
● How will you decide?

>> The fear that their transition experience will be poor
Just like another owner they know or have heard about

Questions:
● Do you know anyone who transitioned out of their business?
● How did it go?
● Why do you think that happened?

>> The fear that the transition process will take up too much of their time so, they feel they need to wait until things are slower

Questions:
● How long do you think a transition takes to execute?
● How much of your time do you think it will take will it take?

>> The fear that their identity is tied to the business
And they will lose their purpose, prestige, and identity when it sells

Question:
● What will you do after your business sells?

FEARS RELATED TO AN EXTERNAL SALE:

>> The fear that they won’t find a buyer
And they’re not sure what they’ll do if that happens

Questions:
● What if you/we can’t find a buyer?
● What will you do if that happens?

>> The fear that an advisor or a buyer will find flaws or shortcomings with their business and they won’t be able to fix/address them

Question:
● What if a buyer finds shortcomings that we’re unable to fix/correct?

>> The fear that they aren’t as profitable as others in their industry
And therefore, their business will be less desirable and/or worth less

Question:
● Are you as profitable as others in your industry?

>> The fear that they’ll have to agree to terms they don’t like
Such as a long payout or the requirement to stay on for one or more years

Questions:
● Are you OK with possibly getting some of the money up front and the rest over time?
● How do you feel about the possibility of staying on for a year or two after the sale?

FEARS RELATED TO AN INTERNAL SALE:

>> The fear that their successor is not yet ready to take over
And may never be…

Questions:
● Do you have a successor in mind?
● Are they ready to take over?
● How do you know?
● How long are you comfortable being away from the business and leaving them in charge?

>> The fear that they need to choose one successor (child/exec) over another, and don’t know how to choose. Plus, they’re afraid of the fallout once they do choose.

Questions:
● Is there more than one possible successor?
● How will you choose?
● What will happen to the one (or ones) you don’t select?

>> The fear of the fallout that will occur when someone (child/exec) wants to take over, and they find out they’re not being considered.

Questions:
● Will you need to reject anyone as a successor?
● What will happen when you don’t select them?
● How will you go about finding a successor?
● How will you keep a successor on board until you feel they’re ready?

Once you’ve determined the various emotional issues an owner is wrestling with, you’ll be able to offer useful perspectives and solutions, including bringing in experts to help with specific problems. Addressing their fears, and providing solutions and perspectives, will establish you as an insightful, thorough, and caring advisor. And it will get them to act sooner than later, thereby helping them maximize their results.

Three Questions Interview

Doug Marshall, an expert at Business Valuation and Value Protection, spent a few minutes with me to ask three good question about finding and developing successors.