A Primer On Business Succession Planning

Business Succession Planning Fundamentals
“Dream as if you'll live forever, live as if you'll die today.” - James Dean

For every business owner the day will come when it is time for him/her to move on. The reason for the departure may be old age, health, disability, familial changes, burnout, or any number of other reasons. Business succession planning involves planning for a smooth transition of the business in the event of the owner’s voluntary or involuntary departure. The impact of business planning goes well beyond the survival/transfer of the business and extends to the financial and emotional well being of the owner, his/her family, and the employees of the business. To be effective, business succession planning should start preferably three years before the anticipated date of the business owner’s exit.

For most mid-market business owners, their business is the largest component of their estate. In spite of this reality, most business owners do not find business succession planning to be a priority. They stay busy with mundane operation issues and neglect succession planning until it is too late. The result of the lapse can be catastrophic. Empirical data suggests that less than a third of family businesses survive the first generation of business ownership. Only a tenth of the businesses make it past the second generation. These statistics would likely be significantly better if the owners did business succession planning. By reading this article, you are already a step ahead of a typical business owner.

No business owner who cares for his estate or his employees should ignore the business planning process. To ensure financial security, and to properly transfer the wealth to the next generation, business succession planning must be a part of the estate planning process. The first step in business succession planning is to understand the end goals of the overall estate planning process.

The goals, for most owners, are financial security, transferring the wealth to the next generation, continuing the family legacy, etc. In translating these goals into business succession planning, the owner is faced with several possible scenarios:

There is a single potential successor: In this scenario the business owner needs to determine if the successor is ready, willing, and able to take over the reins of the business. Increasingly, the potential successor, typically a son or daughter, has interests that differ substantially from the business owner’s.
In some cases, even a capable and able successor may not have the motivation and drive necessary to take over the business and make it flourish. The business owner needs to contemplate if a transition to this successor will result in the desired financial and other outcomes. If the business owner suspects that the estate’s goals are not likely to be met with the transition, then (s)he needs to determine if it makes sense to recapitalize the business or sell the business and transfer the proceeds to the estate.

There are multiple potential successors: It may sound logical to split the business among the successors and give them different roles in the company (some roles could be operational and others could be non-operational). Empirically, a business with multiple owners tends to wither away as each stakeholder pulls it in a different direction. It is common for multiple successors to be embroiled in a power struggle that tears the company apart and negatively affects the interests of the family, the estate, and the employees.
The other common problem with multiple successors is that the successors who end up becoming active owners will very likely end up getting a dramatically larger share of the benefits of the company at the expense of the non-active owners. Unfair distribution of wealth and the violation of rights of minority shareholders is a common theme in many family business transitions.
Given these realities, multiple successors pose a particularly difficult choice for a business owner. The owner needs to seriously consider how the business may be run by multiple successors in his/her absence and see what steps can be taken to arrive at an equitable and harmonious transition that preserves the will of the estate. If the owner wants any semblance of equity and harmony in such a situation, advice from a competent business succession planning expert is mandatory early in the process. If a fair and cordial resolution is unlikely or unsustainable, the owner and the heirs’ interests may be better served by selling the business and distributing the proceeds to the heirs.

There are no likely successors: If there is no potential successor that could run the business, the choice is clear and the best value for the business can be attained by a recapitalization or a planned sale.

Regardless of which scenario the business owner finds himself/herself in, the planning process should begin early so that proper arrangements and precautions can be taken to maximize the value of the business. The outcome of the business succession planning should include a clear understanding of the goals, the process to achieve the goals, and contingencies in case of unexpected developments.

Can You Afford To Employ A Dual Agent In A Business Sale?

The pitfalls of hiring a dual agent in a business sale transaction

Most people have heard of dual agency in the context of a real estate transaction and have some awareness of the issues surrounding dual agency. In spite of the inherent conflict of interest, many people do not mind transacting residential or commercial property using a dual agent. The reason is pretty straight forward – while there is risk of not getting good representation, the downside is typically small. Property values are driven by comps and cap rates and in most cases, the amount of money left on the table is a small percent of the transaction value. The commodity nature and relative liquidity of real estate also helps make buyers and sellers comfortable with the risk level.

But does this logic apply to business sale transactions? Businesses, compared to real estate, are illiquid and the valuations and the ultimate closing prices vary dramatically from business to business. The deal amount can also change dramatically through the duration of a deal. In Business sale transactions, not having a fiduciary agent working for you can cost you plenty.

Let us start with an explanation of “fiduciary duty”. An agent used to represent a buyer or seller in a business transaction has a fiduciary duty. A fiduciary duty is the highest standard of care imposed at either equity or law. A fiduciary is expected to be extremely loyal to the principal. Among other responsibilities, a fiduciary must not put their personal interests before the duty and a fiduciary must not profit from the fiduciary position without express knowledge and consent of the principal. A fiduciary also has a duty to be in a situation where there is no personal conflict of interest and where there is no conflict of interest with another fiduciary duty.

In light of large sums of money at stake in a business transaction and these fiduciary responsibilities, let’s look at the three key issues faced by a dual agent in a business sale.

1. Conflict of Interest
This is by far the most obvious and most damning part of being on both sides of a business sale transaction. A business intermediary is obligated to serve the best interests of his or her principal. Buyers and sellers by definition have conflicting interests. Who should the intermediary be loyal to? Is the agent looking after your best interests? Some agencies will tell customers that they will assign separate individuals to the buying side and selling side and create a Chinese wall.
In practice, the wall between the two sides in the same company, even in a large company with processes to cover this type of conflict of interest, let alone a typical small to mid market intermediary, is more akin to a sieve than Chinese wall. An agency in this situation is in violation of the standards of being a fiduciary.

2. Advocacy
Any competent agent will tell you that, when two principles’ interests are in direct conflict, the agent cannot advise, advocate, or give allegiance to either party if such counsel gives one party an advantage over the other. Not remaining neutral or showing favoritism would be illegal and can make the agent liable to potential damages. A careful dual agent would shun the risk of advocacy and will tell you that they will be extremely careful to represent both parties equally and fairly. In other words, both parties lose "advocacy" for their best interests! Is this what you pay your agent for? Wouldn’t you rather pay an agent that advocates your interests?
In practice, providing equal service to two parties is difficult and, even if the agent is highly ethical, agent’s biases and self interests may tip the scales in difficult situations.

3. Sensitive Information
A business sale can take an extended amount of time and the seller or buyer may experience one or more personal events which, while not affecting the performance of the business being transacted, may have substantial impact on the negotiations. The agent may become aware of this sensitive information which, if disclosed to the other party, could harm one party and benefit the other. If the agent has one principal, clearly the agent will develop a strategy to minimize the impact to the principal. How does a dual agent handle this type of information about a client? Would you trust your sensitive information with a dual agent?
In practice, the agent ends up playing favorites or in a worst case scenario, one or both of the parties’ interests are sacrificed in the interest of “getting the deal done”.

Summary: Business sellers and buyers need to carefully pick their agent in a business sale transaction. Providing equal service to both clients is practically impossible in most deals. In the best case scenario, neither the seller nor the buyer is getting an advocate. In the worst case scenario, one or both of the parties are being sacrificed. For this reason some states do not permit dual agency. Much can be lost by employing agents who put themselves in the position of being dual agents and thus not living up to the fiduciary standards.
For most business owners, a business sale is a once in a lifetime event with significant impact on how well the family’s nest egg is feathered. With so much at stake, can you afford to employ a dual agent?