Living without warning – why succession planning is vital to corporate survival

DIVIDING up corporate kingdoms has never been any easy task. It’s been the cause of many a legal battle, the end of alliances and friendships, and the ruin of many a good enterprise.

But succession planning is often the last box left un-ticked on the “to do” list. For start-ups thinking about how best to exit is often the last thing on their minds and for established firms rocking the status quo seems like a complex and costly exercise. After all, if it isn’t broken then why fix it?

However, boards who avoid the sticky issue of succession management are doing so at their peril. A core element of any risk management assessment, it covers eventualities such as the departure or death of senior staff/directors, the souring of partnerships, and not least the ability to identify a successor and develop future talent. Such issues have the potential to seriously affect a company’s attractiveness to potential buyers and during difficult economic times could easily put off prospective buyers. At the end of the day, business sales are as much about people as they are about profit margins and assets.

It’s not just smaller organisations that are a little too relaxed in their succession planning. According to research by performance and talent management solutions specialist SuccessFactors, two thirds of companies don’t hold managers accountable for developing talent and fail to put effective succession planning in place.

Although 76% of organisations had some kind of succession plan in place, 40% lacked any process or capability to identify future talent. Alarmingly, the survey also found that more than two thirds of organisations surveyed didn’t hold managers accountable for developing their talent or only paid lip service to this.

Only half the organisations surveyed assess (at least once) the capability of their employees. These organisations have pockets of individual managers assessing employees, but in a scattergun fashion. These findings support previous research that suggests that a major reason for people disengaging at work or leaving voluntarily is a result of lack of career development and advancement opportunities.

But for firms with exits firmly set in their sights failure to develop talent (or secure it) could delay or even put off a sale as Richard Feltham, a director in accountants Garbutt & Elliott’s Leeds-based corporate finance team.

 “We are currently working for two clients to find them a suitable leader for a management buyout (MBO) team,” he says.

“There is no one in either firm that has the industry experience needed. A sale in either case will be months away.”

According to Feltham, companies currently looking to sell are tending to fall into two categories. Those whose owner/managers have failed to invest in second tier management, either because they haven’t got an exit strategy or were only thinking of investment in the short term, and those who are actively seeking management buy-in. However, incumbent management teams will always have an advantage.

“Existing management teams will know what to expect,” he says.

“There will be fewer surprises. From a financial backer’s point of view an MBO is always preferable. They understand and know the business and in many instances have been responsible for its operation with the owner having stepped down in all but name only.”

Grooming a successor is not an overnight process. Feltham suggests that ideal candidates should be readied for succession three years before exit. But it’s easier said that done.

“All too often owner/managers believe that only they can do the job. They may be looking towards an exit but simply can’t hand over the responsibility. It’s a common situation.”

As the credit crunch continues to wreak havoc, strong management will prove essential for continued deal activity. Feltham feels that despite a slowing economy, deals will continue to be done but that there will be an increase in vendor deferred income.

“I think there will be an increase in the number of owner/managers retaining a small stake in the company as it spreads the risk,” he says.

However, readying for exit is one driver for good succession management – avoiding disaster is another. And there are many business killer scenarios, which all too easily could transform an otherwise watertight company into a leaking ship.

Patent issues, companies set up in direct competition, patent ownership, commercial intelligence/knowledge loss, share valuations, dividend pay-outs – all situations that can be managed effectively and even prevented.

They’re potential pitfalls that Tim Ratcliffe, corporate partner at law firm Gordons’ Bradford office, tries to bring to business owners’ attention.

“An Article of Association can often help business owners focus on the importance of succession planning,” says Ratcliffe.

“It can make people think about their relationship with partners and investors. What would happen if a good offer was made for the company for example, or a partner died or was injured?

“If a partner left do you pay them off, do they have rights and should there be some restriction on to stop them competing against their former venture? All questions businesses should be asking themselves.”

Seeing it written in black and white, succession management seems like an exercise no company would neglect, but Ratcliffe agrees with Feltham. All too often it’s left to the last minute perhaps on the breakdown of a partnership (in Ratcliffe’s experience two is a bad number) or when preparing for a trade sale.

“Private equity will expect to see succession planning,” warns Ratcliffe.

Why so few companies embrace succession planning is something of a mystery when poor practice comes with such heavy penalties. Perhaps it’s thinking about the unthinkable (no one likes talking about death), or a lack of time for introspection that puts boards off.

For Simon Trobridge, director in the entrepreneurial business team in the Leeds office of business advisory firm Deloitte, there’s no time like the present to start up succession discussions – even for those firms who are hoping to keep things in the family.

“Difficult economic times bring management into sharper focus because only the best managed businesses continue to thrive and prosper,” he says.

“It is therefore crucial that all businesses, including SMEs, consider their current management structure and plan for future development. The plan should therefore have clear objectives, based on what is best for you, your family and others involved in the succession, either regarding management or ownership of the business.”

Trobridge recommends that owner/managers should also consider whether the transfer of management or ownership will damage the business, reduce its value or lead to insecurity among employers, customers or suppliers. But he warns that the final step in a business succession comes when ownership is actually transferred to the successors.

“This involves assigning a value to the business, structuring the sale or transfer, determining adequate financing, obtaining security if the proceeds are payable over time, and mitigating tax.

“Although the finance of the purchase is usually the buyers concern, there may be occasions, particularly in the current climate, when a vendor needs to help the buyer obtain the finance or defer proceeds, for example when selling to a family member, co-owners or employees.

“When sale proceeds are not immediately receivable you will need to take adequate protection in case the purchaser cannot pay the full purchase price. Generally it is harder to obtain security on a sale of shares than it is on a sale of assets. Methods you can use to improve the security of your debt include obtaining life assurance on the buyer’s life, having the shares as security for the proceeds so you regain control of the company if you don’t receive full payment, and taking a specific charge on the assets of the company as security.”

Whatever the reason, not having succession management could mean the difference between a successful exit and a failed one. It can also protect enterprises, shareholders and wider stakeholders from potential disaster. At the end of the day safe is better than sorry.

Succession management top tips

• Think about what happen if a senior member of the management team died or was injured. Does the company have key man insurance for example?
• Consider protecting your commercial interests if a former director set up a rival business. Restrictions can be put in place, but often shareholder agreements offer the best protection rather than service contracts.
• Consider a golden handcuff arrangement to ensure continued financial stability in case of sudden departures or resignations.
• Carry out risk assessments on the management team. Are there any skills or age gaps and if so what processes can be put in place to mitigate those risks?
• Establish a timescale to exit. Is the company to be sold at retirement (and if so what is considered retirement age) or in the next five to seven years?
• Agree shareholding, cross-options and dividends.
• Agree how best to value shares – for example good will.