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.

The Opportunity

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.

Source:

Passing on the Business to the Next Generation, Canadian Federation of Independent Business, 2012

The Succession Conundrum: Business leaders, the weak link to successors, and the companies who try to finance them (Part 1)

Published by the Canadian Venture Capital Association in Private Capital

Business succession planning is tricky; part old, part new, part money, part emotion; it’s no wonder that so many business leaders put it off.  The reality is that an abundance of Canada’s small to medium sized businesses (more than half, according to a survey conducted by the Canadian Federation of Independent Business) don’t have a succession plan at all.  Since companies in this category are responsible for generating approximately one half of the Canadian economy, there is undoubtedly cause for concern.

Consider some of the key survey findings (1):

  • 51% of business leaders surveyed indicated that they don’t have a business succession plan.  Of the 49% that have a plan, only 9% have a formal, written plan
  • Approximately 48% of business leaders plan to exit their company within the next five years
  • 48% plan to exit their business by selling to buyers unrelated to their family, while approximately 37% plan to sell or transfer the business to family members
  • The top barriers to succession planning include finding a buyer/suitable successor (56%), valuing the business (54%), and securing financing for the successor (48%)

Those who have even a moderate interest in the issue of business succession likely realize that various surveys and sources of information have yielded similar results.  Delving beneath the surface, however, reveals interesting implications for business leaders, their potential successors, and those who seek to finance the transition, some of which should be sufficient to kick-start those seeking an exit anytime soon into action.

The Business Leader Perspective

Since over 85% of business leaders surveyed identified retirement as their reason for exit, it stands to reason that many have invested a considerable amount of time and effort into building their company.  As a result, a transfer of ownership represents the primary opportunity to monetize value that has appreciated over what could be a lengthy period of time.  Although this increase might be significant as compared to that of inception, business leaders are often dissatisfied with the offers they receive, which reinforces the need for thorough, early, and practical succession planning to maximize value wherever possible.

What’s even more compelling is how dependent a business leader’s ability to cash out at what they consider to be an acceptable value actually is upon the ability to identify a potential successor who has the: (i) skills to lead the business; (ii) interest in doing so; and (iii) ability to secure financing.  This is a tall order, since many successor candidates might only meet one or two of these requirements.  Couple this with a lack of experience in terms of developing a business plan to take a company forward in a manner that provides the necessary level of comfort to secure enough financing to close the deal.  In the absence of third party financing, business leaders are left with the gamble of whether or not the company, under new leadership, will be able to generate a sufficient amount of cash over time to pay what could be a significant portion of the proceeds related to the transfer of ownership, a scenario that doesn’t end well far too often.

The Opportunity

Business leaders and those in the financing field both have a vested interest in terms of how Canada’s succession planning future plays out; the former wants to cash out and the latter wants to roll cash back in.  In order to avoid a time-consuming stalemate in a situation where time is of the essence, an opportunity exists to help potential successors become real successors, by providing the tools to take companies forward; the right skills, plan, and leadership ability (and a bit of extra effort to help get the deal past the goal line wouldn’t hurt!).  Here’s how:

Business leader skills. Many potential successors have played a second tier role in their careers, without having had the opportunity to ascend to the CEO level. Since the top job can be quite different from what has been the experience thus far, potential successors need a transfer of knowledge, mentoring, and practice in abundance, prior to formally assuming the CEO role.

Existing business leaders can help by creating professional development plans, delegating areas of responsibility in a meaningful way, and taking the time to provide practical mentorship.  Potential successors often complain that leaders don’t take the time to provide meaningful coaching; sadly, this is too often the case.  Doing so can be the difference between a well prepared leader and one who stumbles out of the gate.

Investor ready business planning. Many potential successors don’t have experience with developing a business plan that is sufficient to secure financing, let alone the process of raising capital.  Business leaders who have lost interest in the company, not stepped up internal planning and control processes, or haven’t had the need to seek financing for long periods of time don’t help the process, resulting in a lack of information and competitive positioning to develop a compelling business plan.

Business leaders can make sound business planning a reality by ensuring that the right systems and information are in place within the company to support successors in putting together a plan that can be financed.  Making the effort to critique existing business models, consider new markets, and understand important industry developments can help to identify opportunities for the company well into the future, all of which bodes well with financial partners, and, in turn, benefits those who are seeking to exit.

Leadership ability. Those who have spent years at the helm of a company understand the importance of leadership skills, particularly in terms of the impact to the business as a whole.  Being a good manager doesn’t ensure that a company will be well led, a reality that is too often overlooked when passing the torch.

Recognizing the value of practical leadership development programs and forums and encouraging involvement can help to groom the business leaders of tomorrow.  Starting well in advance and providing practical opportunities to put learning into practice are not only a powerful combination for success, this approach can also identify situations where an individual is not a good fit for a leadership role.  Business leaders that do not encourage this type of development are effectively “boxing themselves in”, in terms of viable succession options.

Facilitating the exit. Financial partners can work with companies approaching (or well past) the need for succession by bringing options to the table, in terms of acquisitions, mergers, successor candidates, and other types of transactions.  In the case where financial partners identify “to do” items to improve a company or go-forward plan to the point where a succession transaction could be financed, facilitating the introduction to advisors who can help makes all the difference, as the complexities of the succession and financing processes make it difficult for business leaders and potential successors to identify the right advisory resources.

The reality is that business leaders have to “help potential successors to help them”; the same is true for financial partners.  In the absence of this approach, it might be difficult to affect a successful transfer of ownership in many cases.  Seasoned business leaders know that a big part of their role is to create an environment that will make those around them successful; addressing the issue of succession really isn’t any different, in this regard.

Where does this leave potential successors?  This topic will be considered in the next installment of The Succession Conundrum.

Source:

(1)  Passing on the Business to the Next Generation, Canadian Federation of Independent Business, 2012