Magazine article The RMA Journal

Succession Planning for a Privately Held Business

Magazine article The RMA Journal

Succession Planning for a Privately Held Business

Article excerpt

Most commercial and business lenders focus on industry, management, and operations as the most important non-financial parts of a credit analysis. A management assessment usually notes whether the business has a succession plan in place and who may be positioned to take control over time. But this is where many analyses stop. We rarely ask for the details necessary to assess the quality of the plan. This article explores seven important elements of a good succession plan, focusing on privately held or family-owned businesses--the most common types encountered by community bankers.

Demographics and business ownership data have shown that a record number of privately held businesses are expected to change hands during the first two decades of the twenty-first century. And even if a business does not change owners and stays in the same family, here's an alarming fact: According to the American Society of Chartered Life Underwriters and Chartered Financial Consultants, only 35% of successful family businesses survive into the second generation of ownership, and only 20% make it into the third generation! (1)

Four of the most common mitigants to the risk of management turnover are 1) depth of in-place supporting managers, 2) various types of "key person" life insurance--both life and disability insurance, 3) business interruption insurance, and 4) buy-sell agreements among the owners.

However, these solutions may not be feasible in many situations and can be a costly drain on the resources of small businesses.

Seven Important Elements of a Good Succession Plan

Here are seven key steps that management should take to ensure an orderly, businesslike approach to planning and managing succession.

1. Select and announce the next head of the business as early as possible. Somebody has to be the boss, and it's more reasonable to choose a successor who fits the position than to pick the next leader and try to make the job fit him or her. Current management should use objective criteria and understand in advance that not all family members will be equally thrilled with the choice.

The current leader shouldn't "waffle," either. Without being too hasty, decisions on the next generation of leadership should be made and announced as early as possible in the transition process, after carefully considering the personal goals and potential roles of all family members.

Expediency in selecting the successor offers the following benefits:

* The new leader has valuable time to adjust and to prepare for the new duties. This may even include taking a job outside the company or earning additional educational credentials (like an MBA) to gain more experience and credibility.

* Everyone else has time to adjust to the new structure and potential shifts in relationships.

* Continuity is established for outsiders such as vendors, bankers, and customers.

2. Plan financial compensation and incentives for the next generation of management. For family members inside the business, one key practice is to structure compensation for rising young family executives that is consistent with that of other key employees and very dependent on objective performance measures. Good plans lay out a compensation structure for the CEO and other senior executives.

For nonfamily employees, continued opportunities to advance based on performance must be stressed. This should mirror the objective, results-based handling of family members inside the business. Any change in business ownership, not just among family members, can be a time of stress for all employees. Key employees should be identified, and plans should be made for employing nonfinancial incentives, such as job advancement and job enrichment, to promote productivity and loyalty.

3. Plan fair provisions for family members not active in the business. This can be one of the toughest areas to handle. …

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