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Successful Succession Part II of VI: How To Maximize The Impact Of Business Transition

By Joe Maier | Johnson Financial Group

8 minute read time

This is the second part of a six-part series focused on planning and implementing a successful succession strategy. The series focuses on a business-owning couple—William, 63 and Susan, 60—along with their three children: Nancy, 28; John, 25 and Amanda, 20.

While this family is fictionalized, its members represent the clients and issues I have worked with extensively over the course of the last two decades.

The first part told William and Susan’s origin story. This second part picks up on the next stage of the succession process: governance—or, as I call it, If not you, then who?

Governance 

As discussed in part one, a successful plan aligns a client’s resources with what he or she wants. Taking that as a starting point, all other factors being equal, the more valuable the resources, the more “wants” the client can fund. These wants cover both clients’ lifetimes (lifetime goals) and what they want for the people they care about after they are gone (legacy goals).

When it comes to business owners like William and Susan, it is almost always the case that their most valuable asset is the business. It is the primary economic resource they can use to meet their lifetime and legacy goals. And the more valuable that business, the more goals owners like William and Susan can achieve. So again, all other things being equal, William and Susan’s plan works best when the business is more valuable.

Taking a step back, there are several factors that influence the value of the business. There are macro-economic factors, there are industry factors, there are competitive factors, and even factors like timing and luck. But inevitably, the primary driver of business value is decision quality. And decision quality is the result of the decision-making process and the talents of the decision makers.

That alchemic combination of the right decision-making process led by the best decision makers is known as governance.

Let’s get back to William and Susan. Remember from part one, William went to work for his father at a young age and worked his way up to CEO by the time he was 45. Later, after his father passed away, he owned 32.5% of Jackson Machining; his three siblings owned the remainder.

William, as is the case with many second-generation owners, learned early on about corporate governance. At Jackson Machining, shareholders owning a majority of the shares have the power to choose the board of directors. In Jackson’s case, that was William’s father until his death, then his mother until her death. Finally, it was collectively him and his siblings. In other words, until William purchased his siblings’ shares, he had no control over who sat on the board. Those directors, acting by majority vote, have full control over the business. Generally, the board selects corporate officers who have authority over business operations. William, as CEO, was Jackson’s highest-ranking officer.

In my experience, second-generation owners, like William—who have to wait to gain decision-making control and then go through the emotional and economic pain of eventually buying out his siblings—design the governance structure to keep a tight hold on control.

And what we learn from William confirms that: he and Susan own all the stock; he is the sole board member; and he is the CEO. In those roles, while he trusts his employees to make some decisions, and gets their input over others, he alone makes every major decision. Those decisions have been good ones, and Jackson has grown under his leadership.

In advising William, it is important to help him understand a counterintuitive mathematical formula: The more valuable William is to Jackson, the less valuable Jackson is to him.

Right now, the primary driver of Jackson’s value is the quality of William’s decisions. Jackson is like Michaelangelo’s sculpture studio…immensely valuable IF Michaelangelo is doing the sculpting, worthless if he is not.

Stated another way, Jackson is a source of income for William, but not a source of wealth. For it to be a source of wealth, it needs to be transferable; and the measure of wealth is what a buyer is willing to pay or how much a non-buying transferee can extract from the operation of the business.

The Business Continuation Plan

Because my job as an advisor is to help William and Susan maximize the impact of their assets to make the impact they dream to make, this concept of business value and governance will form a centerpiece of the advice I provide. The first governance “problem” that has to be solved is crafting a Business Continuation Plan.

So, let’s start with the end in mind. What is a Business Continuation Plan? It is a memorandum we help William prepare that answers eight fundamental questions:

  • What is your role?
  • In that role, what decisions do you make?
  • What information do you use to make those decisions?
  • If you could not make those decisions, do they need to be made or can they be deferred?
  • If they need to be made, who is the best person or persons to make them?
  • How do they get the information you use to make those decisions?
  • Would they process the information the same way you do?
  • Would they come to the same decision you would?

Getting Owners To Take Action; Current-State Analysis 

In my experience, these are almost always incredibly difficult questions for owners like William to answer. The answers require humility, creativity, vulnerability and clarity. Answering these questions generally takes a couple of different meetings with a fair amount of owner homework and thinking between meetings. And owners almost never initially enjoy the process and rarely want to spend precious time. So how do we convince William to invest the time, energy and emotion to undergo this process?

We start with a current-state analysis; what we sometimes call a governance audit. For example, for William, we would assume that he dies or becomes incapacitated. We then analyze how business decisions get made. First, we look at the bylaws and estate planning documents to determine the following:

  • When the CEO is unable to act, who, by role, is authorized to make CEO-level decisions?
  • Who is in that role?
  • Presuming the board has the power to appoint and remove the CEO, who are the directors that have the power to appoint a new or interim CEO?
  • What is the constitution of the board? Are there directors when William cannot act? If so, under the bylaws can those directors act without William? For example, if there is a two-person board and majority consent is required, how do the bylaws address an incapacitated director?
  • If new directors are required, who are the shareholders? Do shareholders who are able to act own sufficient shares to take action?
  • Who votes William’s shares upon his death or incapacity?
  • So, we know that William and Susan own the shares, that William is the only board member, and that William is the CEO. And let’s assume that Jackson’s bylaws have the following typical provisions:
  • When the CEO is unable to act, Jackson’s Vice President can act. But Jackson, like most companies I’ve worked with, never appointed a Vice-President given it’s a generally meaningless role.
  • The board, by the majority vote of its directors, can appoint and remove officers. Jackson has no legally competent directors.
  • The shareholders can remove and appoint directors by a majority vote. Susan does not own a majority of the shares and cannot act unilaterally.
  • As mentioned in the first part, Susan and William have done very little planning, and have no estate planning documents.

So, at the time something happens to William, no one has the authority to make business decisions. There is no CEO, there are no directors and Susan does not have the voting power to remedy that problem. If William is incapacitated, Susan will have to file court papers to become his guardian; if he is dead, she will have to file to become his executor. Both processes take time. In the interim, Jackson will, at best, have the “right” decisions being made by unauthorized decision makers. At worst, the company’s operations will come to a grinding halt due to a lack of authorized decision makers.

Neither possibility bodes well for the success of Jackson; this structure damages, rather than protects or enhances, its value.

Conclusion 

In my experience, highlighting the current state focuses owners like William on the destructive inevitability of inaction. William will quickly grasp that perhaps the most critical business decision he will make is “if not you, then who?” William will understand the need to answer the eight critical governance questions.

Those answers, contained in the Business Continuation Plan, will then lead to next steps including amendments of the bylaws and drafting of commensurate estate planning documents that empower the right decision makers upon William’s death or incapacity.

Inevitably, this focus on protecting Jackson in the case of an emergency will get William to start thinking more acutely about the value of Jackson, his impact on that value and the realization that the tightness of his control is adversely related to the value of Jackson to him and his family.

That focus on the value of Jackson, now and in the future, is at the crux of what we will focus on in part three of the planning process: crafting the financial plan.

ABOUT THE AUTHOR

Joe Maier

Joe Maier

SVP Director Wealth Strategy JD, CPA | Johnson Financial Group

Joe has extensive experience helping high‐net worth individuals, family offices, business owners and corporate executives meet their wealth and legacy goals. His areas of specific interest and skill include business succession planning, financial and estate planning, and wealth transfer strategies.

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Part I: The Origin Story and Background

This is the first part of a six-part series focused on successful succession strategy written by Joe Maier, SVP Director of Wealth Strategy. This series will focus on a business-owning couple: William, 63 and Susan, 60 and their three children: Nancy, 28; John, 25 and Amanda, 20. While this family is fictional, it represents clients and issues I have worked with extensively over the course of the last two decades.

Learn More About How To Maximize The Impact Of Business Transition
Senior Couple Meeting with advisor

Part II: Planning and Implementing Your Strategy

This is the second part of a six-part series focused on planning and implementing a successful succession strategy. The series focuses on a business-owning couple—William, 63 and Susan, 60—along with their three children: Nancy, 28; John, 25 and Amanda, 20.

Read More About How To Maximize The Impact Of Business Transition
Senior couple with consultant

Part III: Your Financial Plan and Your Business' Role in It

This is the third part of a six-part series focused on planning and implementing a successful succession strategy. The series focuses on a business-owning couple—William, 63 and Susan, 60—along with their three children: Nancy, 28; John, 25 and Amanda, 20.

Read More About How To Maximize The Impact Of Business Transition