By Mark Leyden
Many owners of successful contracting firms are reluctant to undertake succession planning and this is understandable given the number of emotional decisions which need to be made. Not only must an owner think about the future of the business but also their own involvement and potentially the involvement of other family members and outsiders.
These owners are not alone. According to PwC’s 2019 U.S. Family Business Survey, 58 percent of family businesses report having succession plans but most are informal and only 18 percent claim to have robust plans in place.
Approaching succession planning in distinct steps makes it clear to the business owner what needs to be accomplished. Here are the seven steps for contractors to create a formal business succession and continuity plan.
1. Define the vision for the future of the company and an owner’s involvement. An owner of a business must know where the business is headed. The plan might be as simple as shutting down the company someday which, if the company is reliant upon the unique skills of the owner or the company is not readily transferable, may be the most realistic outcome. The company could be transferred to the next generation or other family members. Employees or outsiders could purchase the company.
2. Identify successors. This just doesn’t mean identifying future owners. It also involves knowing of those currently employed, who could be a key manager or executive. Methods for training, retaining and rewarding will need to be implemented. If the current employee pool lacks leadership potential, a plan to recruit that talent should be a priority.
3. Plan for contingencies. This means planning for “what if” scenarios. What if an owner or other key employee dies or becomes disabled? What if a key employee leaves the company? What if an owner gets married or divorced or has other family members they want to have working for the company? Closely linked to all these scenarios involving personnel are questions about the shares of the company any of these individuals might hold and what happens to those shares.
4. Communicate the plan to others. For a succession plan to be effective, it must be shared with those on whom it has an impact. Successors should know the opportunity ahead. Family and non-family members alike need to understand their roles with respect to the company. These conversations can often be difficult, and many companies bring in professional facilitators, often attorneys, to help.
“The more communication, the better,” says John Olivieri, a Partner in the Indianapolis and New York offices of Barnes & Thornburg, LLP, whose practice focuses on estate and business succession planning. “In the absence of communication, family members will have expectations which may be unrealistic and can lead to disharmony and litigation.”
5. Obtain an updated business valuation. An independent appraisal to determine the fair market of the company is useful for both personal and business purposes. From a business perspective, the value to each owner is important for buy-sell and key person provisions and for funding any liabilities which arise from having to apply those agreements. “When interest in a family business is to be transferred to the next generation, it may be necessary to start by reorganizing the capital structure of the company,” says Dan Rosio, ASA, the partner-in-charge of Katz, Sapper & Miller’s Valuation Services Group in Indianapolis. “This often involves classifying a small number of shares as controlling so that a majority of the shares, which are non-controlling, can be gifted or sold to other family members. There are similar considerations for transfer or sale to non-family members.”
6. Formalize the plan by creating or updating supporting documentation which include:
§ Shareholder agreements
§ Buy-sell agreements, including trust agreements where there are intra-family transfers
§ Key-person agreements
§ Key-person compensation arrangements
§ Power of attorney(s)
§ Legal will
7. Implement life insurance to fund identified liabilities arising from the succession plan. Life insurance provides the liquidity to make good on promises made in various of the planning agreements at any time. Under a buy-sell agreement, funds are readily available to purchase the shares of a deceased owner. The same policy can also be used to provide additional proceeds to the family of the deceased owner. Many key person executive compensation programs are funded with life insurance. Additionally, where a business is left to one or more family members to the exclusion of others, life insurance can ‘equalize’ not inheriting the family company.
Perhaps the most important thing a business owner should understand when faced with creating a succession plan is that the plan will not be set in stone. Changes should be expected and usually do not create complications as long as they are well documented and communicated.
Growth of a business often creates imbalance in the succession plan. Agreements, valuations and life insurance funding can become obsolete in a company that is expecting growth. Most importantly, any liabilities impacted by changes to a succession plan should be evaluated along with the life insurance funding solution in place to see if existing coverage should be re-positioned or if additional policies are needed.
Mark Leyden, CLU® is the CEO & Founder of Mark Leyden & Associates, an Indianapolis-based firm specializing in assisting businesses and families in the acquisition and management of life insurance assets. [email protected] 317/566-2191 https://MLAssoc.com