Succession Planning

John Ward wrote in his bookKeeping the Family Business

Family businesses make up 90 percent of the 15 million businesses in United States.

They account for 50 percent of all wages paid and 40 percent of the GNP.

One-third of the Fortune 500 are either family owned or family controlled.

In a survey by Leon Danco recorded

in his book Beyond Survival

When a founder-owner ages or dies, the vision which drove the family business often fades or dies as well.

Almost 70 percent of family businesses do not survive the second generation.

CONTINGENCY PLANYou can’t always predict the future

A contingency plan covers the unexpected.

A succession plan is an organized plan to transfer the ownership and management.

CONTINGENCY PLAN

Insurance Buy-Sell agreements

Instructions for the survivors Names and phone numbers What should they do first Who should they consult Your wishes for the future of the

business

SIGNALS TO BEGIN SUCCESSION

SYMPTOMS of UNDERLYING ISSUES

Is there Customer dissatisfaction? Is the company losing market share? Is there low employee morale? Is there high employee turnover? Is absenteeism on the rise?

SYMPTOMS of UNDERLYING ISSUES

Have you noticed any dependency problems?

Do you notice emotional flare-ups? Are there sales increases that do not

translate to profit? Does the owner deny that any

problems exist?

SYMPTOMS of UNDERLYING ISSUES

Has the business failed to grow beyond its initial product?

Does the owner deny the need for change and innovation?

Does the owner suffer from burnout and is the business becoming tired and aged along with the owner?

SYMPTOMS of UNDERLYING ISSUES

Do the family needs overwhelm business realities?

Is there poor communication and inability to confront issues?

Does the current owner spend more time outside the business?

Has the business aged along with the owner?

HOW PREPARED ARE YOU?

HOW PREPARED ARE YOU? Do you have definite ideas about your

company’s direction for the next five years?

Do you have these ideas documented in the form of a strategic plan?

Is the plan supported by task plans with(achievable) milestone dates?

Are your employees committed to accomplishing this plan?

HOW PREPARED ARE YOU? Have you defined your personal goals,

including financial, for the next five years?

Do you have these goals documented? Do you have specific and achievable

plans foraccomplishing these goals?

Do these plans include transferring value out of the company?

HOW PREPARED ARE YOU?

How would you rate your organization’s effectiveness?

What are the prospects for your company prospering over the next five years?

Are these prospects diminished by your absence from the business?

GET THE TEAM READYFollow the two rules

RULE #1 WHO IS ON THE TEAM

Owner Successor(s) Stockholders Family members Key company employees Attorney

RULE #2 THERE SHOULD ONLY BE ONE TEAM

AccountantFinancial PlannerKey SuppliersBankersAdvisors (Peer group)Friends

GOALS

WHO SHOULD SET GOALS Owner Company business plan Successor(s) Spouses Children Shareholders Key employees Other family members

PICKING THE SUCCESSOR

PICKING THE SUCCESSOR

Henry Ford once said that the question

“Who ought to be the boss?”is like asking

“Who ought to be the tenor in the quartet?”

PREPARATION OF THE SUCCESSOR

What skills, attributes, or temperament must this individual have?

Has the successor been given behavior assessment?

Should there be experience with another organization?

PREPARATION OF THE SUCCESSOR

Does the formal education match some of the business needs?

Is the entire team aware who the successor is?

What are the successor’s goals?

PREPARATION OF THE SUCCESSOR

Is there a plan to attended college or industry courses that will add to the skill level?

Does the successor attend seminars? Does the successor belong to outside

business organizations?

PREPARATION OF THE SUCCESSOR

Has the successor had the opportunity to work in each aspect of the business?

Has the successor begun the process of attending all key meetings?

Has the successor begun to chair various meetings?

PREPARATION OF THE SUCCESSOR

Are there any business secrets or information you have not shared with the successor?

Has the successor began to have control of the areas that they have been assigned?

Do not over criticize when mistakes are made.

PREPARATION OF THE SUCCESSOR

Does the successor share the company vision?

Give them confidence by leaving alone for periods of time.

Let the successor make some changes in the business direction.

HURDLES TO OVERCOME

Realistic goal setting Solving family conflicts Recognizing stages of life (and

their impact on business decisions)

Commitment How to let go

HURDLES TO OVERCOME

How much does the owner(s) need to retire?

Everyone's emotions Keeping key employees during

transition Paying estate taxes without forcing

the liquidation or sale of the business

HURDLES TO OVERCOMEConverting business assets into

retirement income Identifying and preparing

successor(s) Adequately providing for a spouse in

the event of death or sale of the business paying estate taxes without forcing the liquidation or sale of the business

BUSINESS VALUATIONIncome approach

Capitalized earnings method Discounted future cashflow method Discounted future earnings method

Market approach Sales of similar closely held

companies

BUSINESS VALUATIONFAIR MARKET VALUE

A price agreed upon between a willing buyer and a willing seller, with neither party being forced into the transaction and both parties having access to all relevant information.

BUSINESS VALUATION

A price agreed Earnings

Before

Interest

Taxes

Depreciation

Amortization

EBITDA**Operational Cash Flow

BUSINESS VALUATION

Asset approach Book value Liquidation value

Hybrid approach Excess earnings method Rules of thumb

OWNERSHIP TRANSFER

MANAGEMENT TRANSFER ISSUES MUST BE CONSIDERED FIRST

Before a logical method of ownership transfer can be decided

One successor should have absolute control

This will avoid problems and disputes in the future

Converting business assets into retirement income

Identifying and preparing successor(s) Adequately providing for a spouse in the

event of death Providing for valuable key employees

while leaving the business to a family member

Paying estate taxes without forcing the liquidation or sale of the business

MANAGEMENT TRANSFER ISSUES MUST BE CONSIDERED FIRST

The appropriate form of corporate ownership to limit potential liabilities (tax and otherwise)

Tax issues associated with potential successionand/or sales strategies

Transition strategies as they relate to owner’sobjectives for income, control or liquidity

Coordinating succession plans with an owner’spersonal financial planning objectives in the areasof retirement planning, liquidity and taxes

MANAGEMENT TRANSFER ISSUES MUST BE CONSIDERED FIRST

OWNERSHIP TRANSFER METHODS

Management Buy Out MBO Leveraged Managed Buy Out

LMBO Leveraged Buy Out LBO Gifting Selling directly to outsiders

OWNERSHIP TRANSFER METHODS

Family Limited Partnership (FLP) A limited partnership among

members of a family

General partners & Limited partners Benefits Reduced asset values

OWNERSHIP TRANSFER METHODS

Family Limited Partnership (FLP) You can control the disbursement of

income The Partnership Agreement governs

how income will be divided

OWNERSHIP TRANSFER METHODS

Family Limited Partnership (FLP) The principle value of the FLP is

reducing a transferor's gift and estate tax

OWNERSHIP TRANSFER METHODS

Grantor Retained Annuity Trust (GRAT)

Is a trust used to reduce gift taxes.

OWNERSHIP TRANSFER METHODS

Employee Stock Ownership Plan – ESOP

Can be used to buy the shares of an owner in a closely held company

OWNERSHIP TRANSFER METHODS

Employee Stock Ownership Plan – ESOP

Can be used to borrow money Can be used to create an employee

benefit plan

OWNERSHIP TRANSFER METHODS

Buy-Sell AgreementsSets forth the conditions under

which a shareholder will sell, and another shareholder(s) will buy, interests in the business

Also establishes the value (or method of valuation) of the company’s stock for estate tax purposes

OWNERSHIP TRANSFER METHODS

Buy-Sell Agreements

Cross-purchase agreements are between shareholders

Stock redemption agreements are between the company and a shareholder

Insurance is the most common form of funding

PHANTOM STOCK OWNERSHIP PLAN

What are the Objectives of a PSOP?

Managers that will act like owners

Managers that are loyal

Head start on an MBO?

PHANTOM STOCK OWNERSHIP PLAN

PSOPs are not “Qualified Plans” In setting up a PSOP you execute a

formal and binding agreement with employees.

PSOPs provide legal rights: Equity Appreciation in equity [stock

appreciation rights] Income

Small number of key executives and managers.

Valuation depends on various circumstances!

Pay-out - Payments generally made over several years.

PSOPs are subject to the desiresof the Board of Directors:

Modification Termination New plans

PHANTOM STOCK OWNERSHIP PLAN

TECHNIQUES

Considerations:

Shared risks Contingent Agreements Variable Sales Price Goodwill v. Operating Expense LT Gain v. Ordinary Income Non-Compete Agreements

GOOD LUCKBe prepared for a: