Most companies both large and small have ownership transition plans and it is not unusual for that initial plan to not work.
According to Joseph Astrachan, PhD, of the Family Firm Institute, about 30 percent of publicly held companies in the S & P 500 Index family owned/controlled businesses survive to the second generation. Another 12 percent will be viable to the third generation and only three percent of all family business will operate with the fourth generation.
As with other critical decisions, it is important to have backup plans in place to protect the owner’s financial future and be mindful of the impact on stakeholders such as employees, key suppliers and customers vested in the success of the company.
If internal succession is not viable, what are the alternatives when it is clear that the chosen successors are not practical solutions to the next generation of ownership?
Here are a few alternative paths that our office professionals have found to be effective directions.
An outside corporate buyer plan has advantages and disadvantages as do all choices.
The owner, in many cases, has the opportunity to sell at a premium price and terms of sale. The transition time and agreement is usually a shorter commitment period.
The outside buyer may have different plans than the seller for direction of the company and the company culture and climate may change dramatically for the employees. In some cases, the corporate buyer’s intentions are not in the employees’ benefit, which may include shuttering the company to improve the buyer’s market share, especially if the buyer is a competitor. Large companies like Apple have used this strategy for market share reasons and to eliminate other competitive threats.
An ESOP (Employee Stock Ownership Plan) option is to have employees become the ownership team.
Advantages are that employees have a better understanding of ownership issues and feel part of a plan larger than themselves with significant responsibility to their fellow owners.
Disadvantages are what employees may not enjoy or appreciate being a part owner and all of the responsibilities and challenges that go with ownership. Not all ESOPs survive over the long term due to ownership and liquidity issues of incoming and exiting owners.
Outside individual buyer advantages include the benefit that the buyer may wish to keep the company culture and climate the same or similar to the seller and wish an extended transition plan to ensure company performance and culture are maintained and is stable.
The statistics on individual buyers on default are high. They have the highest default risk compared to other buyer arrangements. There are many factors including their wherewithal to pay on the sale price and terms. Many of these contracts require multi-year installment payment plans because of the financial condition of the buyer. The individual buyer’s personal financial situation may change dramatically during the buyout period, which makes this buyer also the highest risk to the seller.
Some owners consider an exit by hiring professional management to handle the operations: daily, weekly and monthly decisions. The owners take on the role of board member and shareholder. The business becomes more of a passive investment — an annuity if you will. It is important to hire and oversee management’s performance well. The business risk is still on the owner. A usual arrangement is to implement generous performance incentives and bonuses to the management team. Implementing performance bonuses also have their risks. How much risk will the company take to improve results, and is the risk warranted? In some situations, the growth plans do not work out as planned and keeping management becomes a major issue.
Also helpful for proper alignment of interests and incentives is to offer ownership to the management team. Accomplishing alignment of goals for the owner and the management team is a challenge.
There are several options to transition when internal succession plans become problematic. It is best to plan succession several years in advance for optimal results. Well-planned succession with backup plans make for an easier — and more successful transition — for the owner and his family.
Scott T. Wait, CPA, a partner with RS Wait of Reno, welcomes your questions or comments at 775.825.7337 or email@example.com; www.rswait.com.