As closely held business owners know, their financial plans, retirement plans and estate plans are inextricably linked to the value of the business. Therefore, a well-constructed plan should minimize (or eliminate) events that can destroy business value.
Those events, known as the “Five D’s of Succession Planning,” are the focus here.
Commonly, the death of a business owner can severely damage, if not completely destroy, business value. This is particularly true if:
The business owner is the business. In my experience, the business owner is critical to the daily operation of the business. While this might be understandable with a one-person consulting or professional services operation, it is as common with, say, machine shops and restaurants. Business owners need to understand that if they themselves are the business, the business has the same mortality risks they do.
The estate plan fails to address leadership succession. The value of any business is primarily based on the collective strength of its decision making. If the estate plan leaves decision-making authority, along with the underlying business ownership, to the wrong decision makers, value may be destroyed.
The plan does not address liquidity concerns. Oftentimes, the death of the business owner creates the need for cash for the business. One of those needs might be to fund a buyout for the business partner of the owner. Another might be to pay estate taxes due on the transfer of wealth, including the business, to the next generation. Other more subtle needs might be to handle a business loan that defaults upon the death of the owner, or to pay a phantom stock payment to an executive triggered by the transfer of the business’s ownership. Not planning for these needs puts the business in the untenable position of needing cash at the precise time it is at its shakiest.
2. Disability or Disease
The disability or disease of a business owner can have a more devastating effect than his or her death. While the reasons are numerous and situational, a commonality is that with death, if the right advisors are in place to assist the family, it is possible that a quick sale to the right strategic purchaser can protect a substantial portion of the business’s value. But sick or disabled business owners, particularly those who have been the decision maker-in-chief for their businesses, may continue to come to work. But going back to the value proposition mentioned above, businesses are only as valuable as their decision making and decision makers. Simply put, if energy, acumen and time are affected by the business owner’s health, the business will lose value.
Nothing destroys value like protracted litigation, where emotions often trump logic. If a couple does not set forth a thoughtful and fair plan of what will happen to a business in the event of a divorce, the business will likely not be around to provide for family members when the fight is over.
It is a well-known axiom of psychology that in the absence of information, people will assume the worst. There are several reasons this is true, including neurology (our brains anticipate loss) and narcissism (we believe the world centers around us, and if we don’t know something, it’s because negative information is being hidden from us). Not having an ownership and leadership transition plan, or having a plan and not communicating it to the critical stakeholders, can have a drastically negative impact on value. People will start talking and drama will ensue. And when drama begins, those people who have professional options (i.e., the stars) run, and those who do not have options (the others), stir the pot. Culture is hurt, decisions are poor, value is destroyed.
5. Desire (or Drive)
This value destroyer is the most subtle but the most common and insidious. Most entrepreneurs I know are big thinkers who love to run fast. When it’s time to manage process and people to intelligently grow revenue, they get bored. Or, business owners who continue to do everything from strategy to execution, big thoughts to menial tasks, and marketing to operations, oftentimes become exhausted. Almost always, they build a team of doers – those who can handle day-to-day tasks in their absence but are not empowered or qualified to make decisions. The result: an exhausted, checked-out decision maker making exhausted, checked-out decisions implemented by doers, not thinkers. And that, over a period of only a few years, can destroy value.
A thoughtful succession plan protects owners and their families from the destructive forces of the Five Ds. Components include the owner’s happiness-maximizing financial plan, the business’s leadership succession plan, and a legacy-oriented estate plan that puts business performance first. Over the next several blog posts, I will focus on how to build a plan to maximize value, maximize happiness and take care of everyone involved.
Joe Maier is senior vice president, director of wealth strategy at Johnson Financial Group.