Chapter 2

Planning for Transition

You Surely Won’t Live Forever!

There are business owners who have flatly refused to deal with this fact and continue to act as if they will live forever. Usually this attitude is accompanied by the statement that the future will take care of itself and they do not want to even think about it. However, this hands-off approach in family businesses does dictate the future course of the business and, very often, dramatically and tragically so. The Internal Revenue Service frequently becomes a beneficiary of this approach. And heirs are often disappointed by the meager returns on the distress sale of the business.

A failure on the part of the founder of a family business to consider succession in all its detail can easily lead to that “no good” son of the owner’s second wife, the one whose father rivaled his son in notoriety, sitting in the president’s chair! Another outcome is typified by the widow being so overwhelmed by the needs of the business that she allows some second-rate advisor to run it into the ground. The size of a business only increases exponentially the possible negative consequences of a lack of future planning; it does not inoculate a business from potential ill effects, as many successful and wealthy business owners seem to think.

Why do owners, whose very success and business longevity point to their more-than-average brain power, choose to ignore these facts or acknowledge them all too late? Some consultants and theorists have speculated that the fear of death and acknowledging one’s mortality prevents planning. However, that is not a sufficient answer. Everyone presumably fears death, and yet that fear does not stop people from planning. In fact, one could argue that the more intense the fear, the more the person would want to plan as a way of controlling events and, at the very least, ensuring some influence over events after death.

A more plausible explanation for the absence of planning is that, in planning for transition and succession, certain decisions and strategies have to be made explicit. Making these explicit, either to yourself or to others, means facing potentially unpleasant facts (“My son whom I love so much is just not up to becoming president”), conflicts (“If I choose my one son, the other will curse me on my deathbed”), and inadequacies (“I have let fear stop me from growing my business”). Many successful business owners do not kid themselves. They know that unless they take careful aim, they will miss their mark—that is, goals for their business, family, and employees. They are willing to confront whatever problems the future might present. For businesses that are slated to become family businesses, transition and succession planning is a hallmark of the willingness to face the future directly.

Unfortunately the process of succession planning too often either is not well thought out or remains incomplete. At least five interrelated factors are constituents of the succession planning process:

Dealing with them adequately and appropriately is essential to a transition that preserves the family business.

Once the issues posed by these considerations are addressed, then the succession plan can be translated by lawyers and financial advisors into a fiscally sound legal structure.

The Needs of the Owner and Spouse

In considering what a founder and spouse need and want for the future, the tendency is often for them to kid themselves. Instead of a “need and want,” spouses frequently express what they wish or what they have dreamed about, be it living on a golf course, traveling, being free of financial burdens, or not being babysitters for their grandchildren. In other words, these wishes are birthed at two extremes—while under the day-to-day pressure that can grate on anyone’s nerves, or during an exceptionally pleasant experience (e.g., deep-sea fishing while in the tropics) that momentarily feels like the discovery of the Garden of Eden version of retirement.

These wishes become very pleasant fantasies that are held close to one’s chest without being tested by reality. This usually occurs in the absence of a heart-to-heart discussion about the transition with a spouse, potential successors, and oneself. The plans of others that might conflict with one’s wishes are not considered. The downsides of these wishes (e.g., being bored deep-sea fishing every day) are not explored. The net result is regret that more planning had not been undertaken. This is best exemplified by founders who, having transferred ownership and management of their business to their successor, want to return to the scene of their previous accomplishments (i.e., the family business they toiled so hard to establish), but find that there is no longer a place for them at the table.

In addition to wishes replacing serious discussions about the future, another log thrown on the fire is the founder’s unrealistic view of the business and what it is worth to an outsider or to a family member. The sale of a business to an outsider is sometimes not sealed because of what has been termed “blue sky thinking” on the part of the seller (i.e., where the seller’s asking price is in no way commensurate with the actual value of the business). Although “blue sky” is more obvious when the business is to be sold, it nevertheless appears in the context of family business succession as well, though more subtly. It reveals itself in ways other than the monetary value of the firm. One form it assumes is the founder’s wish that his way of doing business be perpetuated, thereby proving the worth of his accomplishments.

In another case,

The prototypical example of inadequate succession planning is the father who retires into the seat of the chairman of the board, leaving his son or daughter as president. However, the father, even though he has relinquished both day-to-day and strategic operations to his offspring, cannot sit still in the back seat. All too often the unstated intention of the father is to “retire” and serve as a consultant, periodically looking over his offspring’s shoulder and being available for advice when needed. However, father (and his son or daughter) never really addressed the issue of what if father’s advice is not sought out and, in fact, is ignored. More specifically, they failed to agree on who is really steering the ship.

The needs of the founder’s spouse are rarely considered in advance of succession, to the detriment of the planning process. Spouses have created their own career, social, and private worlds. They may have businesses or jobs of their own or they may work in the family business; they have their own network of friends, social groups, and charitable organizations. In brief, they have their own world of obligations, responsibilities, desires, and needs independent of the business owner. The impact on the spouse’s world of a husband’s retirement or slowing down can be considerable. Having a full-time husband at home can disrupt the spouse’s routines and activities.¹

More generally, a husband’s retirement and his increased presence in the daily life of his spouse require that the two “renegotiate” their marriage concerning decision making, roles, expectations, lifestyle, and more. During the many years the husband worked and came home at night, the couple developed a system of divided labors in which decision making assumed a particular form—for example, mother’s decisions held sway in particular areas and father’s in other areas. With father occupying the home on a full-time basis, this all changes. A more dramatic but parallel example of this shift in decision making and role assumption is the experience of military families where the husband has been deployed for a year or more overseas and then comes home on leave, at the end of his tour, or as a result of being discharged. During his absence the wife has taken on both roles—that of husband and wife. She has established routines, made decisions, and assumed authority in different areas. When her husband returns, he has to ask himself what his role is given that a working system is already in place. Renegotiating the relationship becomes crucial to their marriage.

A failure to undertake this renegotiation process has resulted in divorces, husbands going back to work or starting a new business, or fathers insisting that their son or daughter “needs” their advice now more than ever.

The Needs of the Business and Management Team

Perhaps the one factor that is least often associated with succession planning in an owner’s mind is the business itself and the management team that runs it. After all, “It’s my business and what I choose to do with it is my decision alone. My major concern is my family.” A sentiment more detrimental to transition and succession planning could not be deliberately crafted! Yes, the business belongs to the owner, and he can do anything he wants with it. But he should not be surprised when his goals become depressingly unattainable.

When the needs of the business and the management team are not considered, all too often the value of the business diminishes, the problems facing a successor can often become insurmountable, and inheritance can be threatened. “Had the Old Man still been in the saddle, the horse would have remained a contender!” is a frequent, though frequently questionable, rationale for business failures during the reign of a successor or a new owner. All too often what faces the new president is inherited management and business problems not solved by the original owner and not appreciated as problems by the incoming president until too late.

The outcome of the story can be stated at the outset: To provide a strong base for transition planning, the vision of the future of the business as a business entity has to be shared by ownership and management. The notion of participatory management only captures a piece of what will be conveyed here. The process of sharing involves

Management and employee participation in setting the course that the business will take enhances commitment and loyalty to and identification with the business and ownership. This is in sharp contrast to paternalistic ownership (either authoritarian or benign) that holds all decision-making responsibility and authority within the shadow it casts; the consequence is that management and employees feel and act as if it’s “we” versus “he.”

Strategic Goals and Action Plans

The “five-year plan” has become either notorious or a joke in many businesses, along with four-year and three-year plans. Either it is too far off to even think about, or it is useless because business conditions are about to change drastically anyway. The assumption is that any such plan is cast in stone, demanding to be followed exactly, and thus impervious to external market conditions. However, that is not the purpose of a good strategic plan.

Whether we own up to it or not, each of us has a set of assumptions about the future.² The sales manager is thinking that if we go into a new product line, he can increase sales dramatically. The operations manager thinks that to be more efficient he needs additional space and equipment, and may even have a picture of exactly what kind of space and what kind of equipment are needed. The comptroller knows exactly what expenses need to be cut in order to increase net. To the extent that they do not know what each other has in mind for the future, much less what the president is thinking, miscommunication, conflict, and mistrust will result. Once a decision about any of these items is made, it forces everyone to reframe their picture of the future, willingly or not. In the absence of communication, the picture frame becomes skewed.

The function of a multiyear plan is not only as a guide to the future but also as a clearinghouse of ideas. The halfway point in this plan then becomes a reality check: What would have to be accomplished by this halfway point to support achieving the goals of the multiyear plan, and can this in fact be done? Whether the halfway expectations are attainable can then be evaluated by what the management team can plan for one year out. The goals of the three different plans (the multiyear, halfway, and one year) can be adjusted until agreement is reached as to whether they are realistic and attainable.

In the previous vignette, this strategic planning process allowed each manager to have his input and thinking considered. They were able to determine the new markets they wanted to enter and the new customers they wanted to pursue; together they decided on the new products needed to compete in this market. They could then coordinate this with a purchase plan for new equipment that fit with what the comptroller considered to be prudent spending. Securing the necessary training, personnel, and software systems was then timed with financial, production, and sales requirements.

With management discussing gross sales, gross profit, net profit, return on investment, and assets, each member becomes aware of his responsibility in achieving these ends. Any disagreements that surface can be resolved. Management is then in a position to translate corporate goals into departmental goals and action plans, and these in turn can be translated into individual employee goals and action plans. Performance criteria, expectations, and goals become clear for all individuals at all levels within the company.

The net result is awareness and agreement, which serve as an antidote to blaming, scapegoating, and failure. In the previous example, the plant manager went from being “an incompetent has-been” to a progressive manager willing to experiment.

Organizational Structure

There are many reasons for how and why businesses succeed or fail. Most of the reasons usually offered are rooted in economics: strategy, marketing, sales, pricing, distribution systems, manufacturing capabilities, and the like. If a company succeeds in outpacing its competition, it is because they were first to market, their pricing was right, they gave their customer what they wanted, or they could fill their distribution channels. A failure, on the other hand, is due to not reading the market right, not investing in updated equipment, providing poor customer service and follow-up, not caring about quality, and similar such explanations. All these rationales, at one time or another, are correct. They clearly merit serious attention.

Another factor contributing to success (or otherwise) is organizational design, a factor that in many ways is more basic than many of these others simply because it undergirds most of them. In fact, its influence is most clearly visible when rapidly growing and apparently successful firms falter or fail.

Organizational design refers to how a corporation, division, or department is structured with respect to how it produces and supplies products and services to its clients and customers.³ As a firm grows, it will (or should) redesign itself at different growth levels, as well as when customer needs evolve. Changes in either factor require changes in how and what products and services are delivered. For those rapidly growing firms that have experience in redesign efforts, it may be a core competency that distinguishes them from their competitors, providing a strategic advantage.

Designing an organizational structure depends on a variety of factors, including

The typical organizational structure is usually a legacy from the firm’s beginnings. What has been inherited is a system based on the needs of previous customers. New customers and different kinds of customers with different needs, expectations, strategies, and concerns jar the sensitive spots of this legacy structure (i.e., those areas that do not or cannot accommodate these new customers). The old structure persists in too many companies with one department (usually sales or marketing) remaining as the “gatekeeper” for the dispersion of customer information. The net result is that the information each department requires to do its job is either lacking, late, or incorrect.

Given the rapidly changing nature of the marketplace, it might seem that virtually all customers are new and changing. Whether this is so or not, the typical organization structure has many problems, including conflicts between departments (e.g., the perennial one between sales and operations), long lead times in developing new products and services, quality problems, inefficiencies (which are usually blamed on individuals), and inability to keep up with customer demands. No doubt there are many factors contributing to each and every one of these challenges, but how an organization is structured is one of the most significant underlying causes.

Family businesses and, indeed, most entrepreneurial businesses facing transition tend to ignore the changes in organization design that may be required. Other issues seem more prominent and demand attention during transition. The emotional upheaval that transition and succession produce can narrow observation. The development of a strategic plan can act as a brake to veering off into such areas.

Once a common vision of where a business is headed can be agreed on, then a decision as how to structure the organization becomes clearer. Maybe the various departments have functioned too independently in the past, causing some unpleasant events. Perhaps the sales force has to be compensated differently (i.e., on the basis of their individual performance) than people in the other departments in order to be as motivated as they should. The manufacturing plant may not be as tightly integrated as required by competition and the market.

Employees and the Management Team

The development of a strategic plan and organizational design issues are key considerations during transition. Entertaining these two aspects of business requires an owner willing to step back and take a fresh look at his firm. It also entails being open to participation and collaboration with his successor and the management team. This also requires a successor who can appreciate the nature of change—that resisting it or embracing it without judicious thought are both detrimental to the success of the firm.

During transition, management and employees have to deal not only with a new president whom they knew when he was in the wings but also with changes in strategy and organizational design that may require a rearrangement in their work situation—there may be different reporting structures, different responsibilities, or different roles. The transition from the founder to the heir can be quite difficult for employees, particularly if the gulf between the founder’s vision of the business and the heir’s is wide. A successful transition plan requires the loyalty of employees and management, which is tested most dramatically when the transition is characterized by uncertainty for any number of different reasons. When employees and management are part of the planning process, are trained to perform their jobs, are given the responsibility to contribute to the growth of the company, and are evaluated, promoted, and rewarded accordingly, their loyalty is rarely lacking. A succession plan that takes into account their needs and concerns will receive their support.

One primary way of assessing management’s needs and concerns is to ask. The questions fall into several categories. The following are only some of the questions that might be asked:

Management and Ownership Transition

The owners of family and nonfamily business share a common dilemma: When, if, should, and how does transfer of ownership and management occur? Owners of family businesses face an additional dilemma: Which comes first, family or the business? The three themes—ownership transition, management transition, and inheritance—are intertwined and their cross threads need to be kept visible. Underlying so many situations where problems arise is the failure to keep in mind that management and ownership are separate and distinct entities.

Ownership and inheritance problems and their legal and financial consequences generally arise

The Terms of Ownership Transition

Owners of businesses often hold out the promise of future ownership either to employees or to offspring without being specific about the terms of the transition. With sons and daughters it is often a “when you are ready” condition where the definition of “ready” and its measuring rod are left unstated. Key employees are frequently offered a portion of the business “when the business really gets going,” with similar imprecise definitions. Key employees usually have little recourse when their efforts to gain precision are rebuffed—all too often their age prevents them from moving to other firms. Their response can take the form of lowered motivation and involvement, often at a time when their experience and contributions are most needed. Also, this pool of disgruntled employees can spawn disloyalty in the form of secretly providing competitors with important company information.

Offspring have other avenues by which to right perceived wrongs and broken promises. Family pressure is often brought to bear in the form of a spouse haranguing her husband to sell or give the business to their offspring who are slaving away in the business. A son’s or daughter’s threat to leave unless ownership is transferred carries more weight than a threat from a key employee—the threat from an offspring can mean the end of familial relations.

The remedy requires a commitment by the owner well in advance of transition to lay bare all details and terms of ownership transfer: exactly when the process will begin, what conditions have to be met by offspring, by what formula the price will be decided, and who can or should or must be involved (e.g., a father may not wish to sell the business to his sons unless both sons buy it on equal terms).

Legacy Ownership

A second source of dissension surrounding ownership transition occurs when the new owner has inherited unwanted partners. These partners may be siblings who have other careers or who have no career at all other than as the company’s cash drain. The family heirloom scene frequently occurs when a parent wants to be seen as fair and equal with offspring so as to avoid any dissension or hurt feelings. It also appears when a parent feels that a son or daughter needs protection and financial security. The unwanted-partner scenario is undoubtedly the greatest single source of lawsuits in family businesses. The successor feels he or she is working hard for the benefit of siblings and unwanted partners, while getting nothing in return except complaints. The partners feel they have a right “to examine the books,” with all that that implies. A more explosive scene would be hard to imagine.

Offsetting this problem is the realization that management and ownership need to be treated as separate issues. One way to keep this distinction in mind is to maintain that only active management entails ownership, thereby clarifying for nonemployed family members the extent of their inheritance. If an owner’s estate is tied up entirely in the business, then some consideration might be given to financial transactions (e.g., a bank loan financing a buyout, a buy/sell agreement funded by insurance, and the like) that reflect this point of view. Granting some form of nonvoting stock could preserve this distinction while simultaneously passing an ownership stake onto family members not in the business,

The intent here is not to offer financial advice, but rather to focus on a goal—namely, keeping in mind the distinction between ownership and management—that is best achieved by consulting with a lawyer and accountant early in the transition planning process.

Planning for Management Transition in the Family Business

The sale of a nonfamily business usually results in a severing of the previous owner’s relation to the business. He might be retained as a consultant for a limited period of time, and his consulting role and responsibilities would need to be defined, but the owner’s participation in the future running of the company would be very limited, no doubt ending at a specified point in the future. The management transition is completed with the sale of the business. Not so, however, in family businesses.

Only in family businesses is the prior owner’s future role in the company unclear even if an outright sale to a family member has occurred. The reason is obvious. His sons and daughters, who are now running the business, are still his sons and daughters, and the business they are running is another one of his “sons” or “daughters,” or is his “lover” or “mistress,” depending on what kind of satisfaction he derived from it. His identity is wrapped up in the business. Thus we have the many stories of founders who remain the behind-the-scenes final business decision-makers after succession while their son or daughter has ostensibly become president.

Transition can be either a very meaningful experience for the entire family or, conversely, a tragedy in the making. One of the primary reasons is that family businesses confuse the issue of which comes first, the family or the business. The assumption is that one or the other has to take precedence. Faced with this dilemma, a founder may be tempted to take the path that causes him the least amount of personal trouble regardless of what impact his decision might have for the business. Thus refusing the presidency of the company to an offspring, even if he is not quite up to the task, could be viewed as detrimental to the family well-being. What is not as frequently admitted is that granting this offspring the presidency may be detrimental to the financial health of the family. This example and other instances of an inadequate successor being selected point to unresolved family disagreements that the family wishes to deny.

In this instance it is evident that the parents had not attempted to answer the questions about succession listed earlier. In fact, this vignette reflects what too often occurs in family businesses, namely, the use of the business as a therapeutic refuge for members of the family. In fact, what would be more therapeutic would be for the inadequate son or daughter to have to face the world in a different business setting and learn how to cope rather than blame.

A Family Transition Plan

Business transition requires planning by the family, the successors, and the management team, in collaboration with legal and financial advisors. It entails information openly shared, negotiations openly arranged, decisions publicly acknowledged. The medium through which transition can successfully occur is family and management meetings where questions are asked and answered and agreements are concluded. To the extent that a business owner denies the necessity for this, to that degree is he or she courting disaster. That it is difficult, that it requires patience and perseverance, goes without saying. But whoever said business was like strolling in a rose garden?

Appendix A contains a roadmap for parents and family to plan and negotiate a family transition plan. It includes sections on meetings to be held, questions to consider, and issues to be resolved. It also contains snippets of the transition plans other families have created. These have been included to give parents and family members an idea of how others have responded.

The Occasion for Estate Planning

Succession and estate planning constitute the heart of family business transition. Succession planning, which is discussed in detail elsewhere, is concerned with the management of the firm. Estate planning deals with the distribution of wealth within the family.⁴ Three areas of conflict often appear when estate planning is the order of the day:

When most of the estate of the founder lies in the family business, parents face the dilemma of how to provide for those not in the business and not drawing an income from it. Even when there are other financial resources available, the family business presents a very attractive avenue for satisfying this responsibility. When this source of financing is used, the best device is separating voting from nonvoting shares, with the latter going to the family members not in the business. The most problem-inducing act is granting these family members voting privileges. In either case, those working in the business have partners frequently seen as unwanted. The feeling is that the results of their best efforts are going to benefit those relatives who have not contributed to the firm’s success. In more tiresome situations, regardless of the status of their equity position, nonworking relatives have been known to throw barbs from the bleachers. Their feeling is that being a family member or a son or daughter of the founder grants them the right and privilege to have their say and that it be heard.

“Sweat equity” refers to the discrepancy in tenure usually, but not always, between an older and a younger sibling. The older sibling has worked longer in the business and feels entitled to a larger portion of the value of the business—after all, he contributed to the growth of the business while the younger sibling was growing up and maturing.

The third situation develops in the third generation, if the family business lasts that long, or in the second generation if two brothers were cofounders and had a different number of children. Equity will then be unevenly distributed among the heirs, along with voting power.

The conflict that develops in these situations is the result of a lack of clarity on the part of the parents’ as to their wishes—that is, a clear statement regarding their intentions.