Many business owners know that planning for the eventual transition of their business provides opportunities to maximize its value and exit on more favorable terms. However, in the real estate and construction industry – where many businesses are family-owned or closely held – there is often more at stake for an owner than just the terms of his or her exit.
A successful transition may also be defined by how well new ownership has been positioned to assume leadership and continue to grow the business. Owners are less likely to regret selling their business if it has been transferred with a plan and tools in place to help the next generation succeed. Consider the following steps that business owners can take now to help position their business for success during and after a transition.
Help new owners with their succession plan
Only about 30 percent of family businesses survive past the first generation. One reason why is that family dynamics and poor planning can quickly erode the ability of new ownership to continue the business. For example, where ownership is transitioned to more than one child, the selling owners and the new owners should consider jointly developing an agreement to resolve disputes among the children regarding management of the business and disposition of equity.
A number of key questions should be addressed. For example, will the other owner-children have a first right to purchase the interest if a child wishes to transfer outside of the ownership group? Can a majority of the owner-children decide to sell the business to a third party? What happens if a child divorces from his or her spouse?
In some cases, the founder or selling owner may want to retain a right to take the business back upon the occurrence of certain events. Transition to the next generation tends to be more successful if the existing and new owners jointly address these questions before the business is handed over.
Align interests with employees and family
Incentives are frequently used to ensure that desired successors stay with the business until ownership has transitioned fully. However, business owners often make the mistake of not planning for employees and family who are not selected to take over. Failure to create an employee retention plan may be seen as a sign of instability for the company, which, if it’s a contractor, may hurt bonding capacity.
Tools such as stay bonuses and incentive compensation can help keep key employees not selected for ownership motivated to grow the company and ultimately achieve the transition. The same care must be taken with family members who do not work in the business. Encourage all family members to participate in the transition planning process and to understand what could happen – both financially and personally – if the transition is not successful. Consider using estate planning and other tools to help these family members feel they have been treated fairly even if they will not receive ownership in the business.
Identify and address operational barriers
The change in ownership and control of a business may trigger consent and notice requirements that, if not followed, could disrupt business operations. For example, many commercial loan agreements and lease agreements require consent before a change in ownership occurs.
For contractors, care must be taken to ensure that a “responsible managing individual” is identified for licensing purposes and that a responsible party is identified for surety bonding. Companies holding Federal Communications Commission licenses for private radio facilities often must obtain approval before there is a change in control. Additionally, companies that do business with the government may be required to seek governmental consents and should analyze the implications of the ownership change on government contracting requirements – such as organizational conflicts of interest and small business qualifications – to avoid disqualification. These are just a few examples, but with advance planning most can be addressed with little disruption to the business.
Formalize business practices and processes
A business that is reliant on only a few individuals with the personal relationships and knowledge necessary to drive business processes is difficult to transition successfully. Document key decision-making practices before the transition and allow time to work through them – with the successors taking an active role. Recognize when the company has outgrown its initial management structure; expanding the management team to include members outside of the family or ownership group can help provide oversight, validation, skills and diversity that will provide new ownership with tools to succeed.
Develop a contingency plan including new ownership
A contingency plan documents how core business functions will be performed if key personnel with institutional knowledge about the business are no longer involved – for example, due to death or disability. The most effective plans consider the goals and objectives of not only current ownership but also planned successors to ensure that a clear path exists to run the business if an unplanned disruption occurs during a period of ownership transition.
A business owner planning to move on may need to consider more than his or her own exit. Successful transitions – especially those to family or employees – require tools that create continuity and opportunities for the next generation to be successful once they take over the business.
Column first appeared in the Daily Journal of Commerce on October 10, 2016.
Ideas & Insights
News and Insights delivered to your inbox