Succession planning for a closely held or family business attempts to balance the interests of various stakeholders while answering the question – Who will own and manage the business upon the death, disability or retirement of the current owner/manager?  For most companies, succession planning focuses on the short and long term replacement of management.  But this fails to address a key issue, especially for a closely held or family owned business – Who will own the equity in the business?  Unintentionally favoring one party over another can have devastating results.

Failure to balance each party’s interests by putting the appropriate documentation in place can cause disruption of the business, employee insecurity, discord among family members, disputes between owners and the loss of goodwill, the primary driver of value. Succession planning should not be confused with strategic planning concepts (where is the business headed) or estate planning (what happens to the assets held by a business owner at death or disability).  But the topics can sometimes be interrelated.  Having a well thought out coordinated plan will facilitate the transition of the business and the owner’s estate to the proper beneficiaries, thereby preserving family harmony and the goodwill of the business.

Before you get started, it is helpful to identify who should be around the table discussing the plan and when. Your attorney, accountant, insurance agent, financial advisor and banker are common answers. See our blog post on identifying a business attorney here How To Select A Business Attorney You should also consider including family members, other significant owners and key employees. For larger, more complex projects, it is easier to start with a smaller group of participants, work the issues, outline the decisions and then circulate the recommendations to the larger group, before any drafting or action begins.  Smaller, simpler projects can get away with just a few participants.

The next step in the succession planning process for a closely held business is to identify and prioritize the group of potential successors.  Potential successor owners include internal relationships like family members, current owners, key employees and external relationships like industry contacts, vendors, customers and competitors, often referred to as strategic partners, and financial contacts such as third party investors, investment bankers and financial institutions.  Identifying and prioritizing these parties at the outset will lay the context for the remaining components of the succession plan.

Once the potential successors are identified and prioritized, the project will start to take shape.   Tasks and timelines should be assigned to the appropriate parties for implementation.  There is no standard form or set of documents for succession plans.  The plan could range from updating the entity’s corporate records to seeking a merger or acquirer.  Each plan is unique, but there are some commonly used documents and tools to address issues.

Documents and provisions for external relationships are discussed frequently – loan agreements, merger agreements, and stock or asset sale agreements.  See our general description of the more common documents here Mergers & Acquisitions.  However, documents and tools for implementing plans with internal relationships are not familiar to most business owners.  Common documents for succession planning for internal relationships include employment agreements, voting trusts or agreements, shareholder agreements, operating agreements, sophisticated bylaws, dispute resolution agreements and irrevocable trusts.  Provisions for internal relationships include non-voting equity, re-capitalization, life insurance, disability insurance, restrictive covenants, sinking funds, put options, call options, business appraisals, valuation formulas and annual meetings.  These documents and provisions can be used alone or together to achieve the desired results in a wide variety of circumstances.

Why is succession planning difficult?  There are many reasons why succession planning fails.  Lack of leadership, unreasonable expectations, over/under valuing the business, unequal participation and contributions, illiquidity, cash flow, taxes, family or ownership conflict, insecurity, risk allocation and age differential.  Succession planning for the closely held or family owned business is complex.  A facilitator must address these tax, psychological, and financial constraints in the context of each family or ownership group and provide solutions.  These issues do not go away and simply become magnified over time if not addressed.  Eventually, an unexpected death, disability or retirement occurs and the parties end up in extended litigation or the loss of the business.  A result that can be avoided by addressing the issues, however difficult, in a properly thought out, drafted and implemented succession plan.  If you would like to tie all these pieces together to create a balanced succession plan for your business, please give DeAngelis Legal a call to get started.