The Succession Conundrum: Business leaders, the weak link to successors, and the companies who try to finance them (Part 2)
Published by the Canadian Venture Capital Association in Private Capital
If succession planning is a challenge for business leaders, potential successors might describe the process as mysterious. While a business leader or founder has typically been at the helm of a company for some time (if not a prolonged period of time, in many cases), potential successors are often just trying to find a way to get to the table. One day, the founder is keen to “step back” from the company, while the next day, “retirement” seems vague and far in the future. For someone wanting to aspire to a leadership (and ownership) role, this type of situation can be a difficult to deal with on an ongoing basis.
Whether a potential successor is a longstanding “2-IC” (2nd in Command), management team group, or family member, their vantage point might provide relatively little information in terms of how the company actually operates, the business leader’s true expectations around succession, and what it would actually take for a transaction to occur. Add in the mixed messages that can be so common with the issue of succession and it might be enough to cause a potential successor to scramble for the door, vowing to create an opportunity all their own (and on their own terms).
This reality should be sufficient to get the attention of business leaders who are contemplating succession, if not outright relying on it as a means to monetize their ownership position. Given that a recent survey conducted by the Canadian Federation of Independent Business (1) found that the top barrier to succession planning is finding a buyer/suitable successor (56%), those seeking to exit their business should recognize that finding (and keeping) a potential successor is not to be taken lightly. Unfortunately, too many potential successors find just the opposite to be the case.
The Successor Perspective
Something that many potential successors have in common is that they are keen; to implement their ideas, take the company in a new direction, and just “get started”. Many have a reasonable expectation that succession will occur at some point in time, either by virtue of previous conversations on the topic, or perhaps, in the case of a family business, where succession is “expected”. Call it an informal succession plan.
As a result, potential successors want to better understand how and when a transaction might occur.
This is particularly true in the case of individuals who have invested a number of years working in a company, learning how it operates and directly contributing to building its wealth. They reach a certain age or point in their careers when they truly need to know: (i) if a succession opportunity actually exists; (ii) when it would occur; and (iii) what the financial implications would be, particularly in terms of the cost to undertake the transaction. In the absence of this information, a successor’s next best alternative is to move on to other opportunities, and given the effort they have invested in building the company (often, to the direct benefit of a shareholder group in which they are not included), this is understandable.
Identifying a qualified and willing successor is only the beginning of the succession process, as there is often still plenty of learning to do in order to fully assume and conduct the leadership role. But even before this can happen, the parties need to be able to arrive at an agreeable value and the successor has to have the ability to pay, either by way of their own funds or through securing financing (in the absence of either of these options, it often comes down to the departing business leader to agree to be paid over time). Since the Canadian Federation of Independent Business survey found that valuing the business (54%) and securing financing for the successor (48%) are the second and third highest reported barriers to succession planning, all involved in the process need to take note.
For potential successors to chart their course, there are a number of things that can be done on a proactive basis to better understand the particulars of the opportunity, as well as getting a plan into place. Seeking advice from those who have undertaken or financed business transactions can help to bring context to the situation, in terms of its appeal and how to help move the process forward. Here’s how:
Look in the mirror. The truth is, not everyone is cut out for a leadership role. Leading a company, in terms of both the role and ownership aspects, can be significantly different from the experiences of a potential successor thus far, including the scope of responsibility, level of risk, and degree of commitment. As an example, in the event of insufficient cash flow, owners typically bear the responsibility to inject additional funds or decrease their own compensation to cover shortfalls. This type of uncertainty might fall outside of a potential successor’s risk tolerance level.
Potential successors need to take a hard look at all aspects of assuming a leadership role, objectively balancing both the risks and rewards of ownership. Advisors can help by providing independent feedback or helping successors to undertake a self assessment to better understand the types of roles in which they fit best, before proceeding any further.
Assess the situation objectively. Due to the inherent uncertainty that often clouds the succession process, potential successors need to be able to get to the heart of the situation, to first understand whether or not an opportunity actually exists. This uncertainty is a relatively common frustration, and the reality is that succession is only going to happen if a business leader is committed to undertaking the process.
Advisors can help potential successors to see the situation for what it is, as well as suggest approaches to further discussions with the business leader or how succession could occur. In addition, successors might need to take action to put the situation in context, by identifying other possible succession opportunities as a comparison. Although business leaders might not like this very much, the reality is that there are situations where succession simply will not occur, no matter how much a founder might indicate otherwise.
Communicate. Given that succession can be a sensitive topic, it’s not uncommon for the parties to have difficulty having meaningful conversations around the issue; this can be particularly true in family businesses. Since succession represents a complex business transaction with numerous details to be considered and negotiated, it won’t just magically happen. Given the sensitivities, these conversations tend to get deferred and delayed, making succession seem less likely as each day passes.
Starting the succession dialogue between the parties is critical, to map out an agreeable approach, but to also identify situations where an arrangement might not be possible, allowing both sides to pursue other opportunities. Advisors can help to start the conversation in a non-confrontation manner, in an attempt to find common ground, where it exists, and cover off areas that need to be addressed. This approach can also help to fill in knowledge and experience gaps that are common in the case of potential successors.
Financial implications. Discussing money is often tough, not just because of the calculations and various financing structures, but simply because the parties might find it difficult on a personal level. In the case of family businesses, parents might be sensitive to the financial situation of their children, while the next generation might be concerned about not “offering enough” as compensation for all of the work that has been put in to building the company. Couple this with a founder’s understandable desire to receive fair compensation to finance the retirement they have been dreaming of and negotiations can stall.
Potential successors often do not have a lot of experience in this area, and financial partners can be helpful in terms of transferring knowledge and suggesting approaches that could meet the needs of all parties. Regardless, those who are serious about taking on a leadership and ownership role at some point in the future need to ensure that their professional development program includes business financing, sooner rather than later.
Although it’s true that good successors are in short supply, all potential successors need to take a hard look at not only what is required of them, but also whether or not the opportunity at hand is viable. In times of investment (and that’s what succession is), bringing a professional approach to the table is a must to ensure that the right deal gets done.
Passing on the Business to the Next Generation, Canadian Federation of Independent Business, 2012
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