Own - March/April 2010
The Succession Planning Crisis
The vast majority of small business owners are unprepared for retirement. Here’s what you need to know to protect yourself and your business.
Retirement. You know it’s going to happen eventually. And when it does, you need a plan for the business you toiled to build, so it doesn’t fall into the wrong hands or lose value.
But if you’re like the overwhelming majority of small business owners, you’re vastly underprepared. And little wonder—you’ve got your hands full running the business, worrying about sales, marketing and staffing. In a 2008 survey of business owners by PNC Wealth Management, part of PNC Financial Services Group, 77 percent of business owners said they have a will, but only 33 percent have a succession plan.
Succession planning may sound like no big deal. Maybe you think when the time comes to retire you’ll simply hand the company’s reins to your able son or daughter. Or call the larger competitor down the street and hammer out an acquisition agreement. Sign the papers, and you’re off to Florida to bask in the sunshine.
Not so fast, say financial planners and business brokers. Crafting and carrying out a viable exit plan can take as long as seven or eight years. All the while, the process is fraught with far-reaching financial and emotional decisions that will determine your retirement path, the fate of the business you worked to build, and possibly even the livelihoods of your children. Take it lightly, or start thinking about it too late, and not only could you be saddled with a bigger tax burden, but your kids could inherit less wealth and your company could end up in the wrong hands—or disappear altogether.
Think Ahead
“The first step in an exit plan is to identify the end point”—your ultimate post-exit goal, says Neil Shroff, managing director at Orion Capital Group Inc. in Menlo Park, Calif., which provides exit planning and acquisition advisory services to small and mid-size companies.
That’s because if you plan to sell to a third party, it can take several years to figure out your company’s market value, optimize your corporate and personal tax structure, find a buyer, close the deal and train a new team. Passing the business on to family requires a different, careful navigation of tax and estate planning rules. And it may take more than a decade to recoup the full sale price from a family member who doesn’t have the cash on hand to pay upfront, as a larger third party buyer might.
But no plan is foolproof. Market forces can get in the way of even the most thoughtfully laid-out plans, as thousands of business owners have found during the recent economic downturn. These days, with business valuations down, a company that once looked like an easy sell may suddenly fetch a dramatically lower value. That’s yet another reason business owners need to establish relationships with accountants, lawyers and financial planners—well before they’re planning to retire—who can help them navigate unexpected economic or personal hurdles.
Even in cases where a company finds a buyer, these days funding is tough to come by. Furthermore, deals that seemed to be set have been unexpectedly derailed by a jittery lender or an acquirer’s unexpected cash-flow crisis. “Plans have all been screwed up,” says Gary Price, partner at San Francisco Bay area accountancy and business advisory firm Sensiba San Filippo LLP. In recent months, several deals for his clients have been repeatedly delayed and finally canceled altogether, after a buyer pledged cash to purchase a small business but couldn’t come up with the money, he says.
On the flip side, the recession and consequent lower business valuations mean it’s a great time to pass the shop on to your kids, and pay lower taxes on the lower value.
That doesn’t mean you should rush to pass your company to your children. Though family succession is often a business owner’s first choice, many of those owners are surprised to discover their kids aren’t as enthusiastic about taking over as they may have thought. “We’re starting to see more of those cases where the baby boomers’ kids don’t want the business,” says Price.
Adult children may want to move to another city or pursue an entirely different career path. Parents who assumed their kids would take over may be caught flat-footed and be forced to scramble for an alternative. In that case, for the business owner, “it becomes an exit strategy rather than a succession,” Price says. It’s just another reason to begin planning as early as possible.
Engineering to Marketing
Even owners’ children who would like to take over aren’t always the most qualified candidates. That can be tough for owners—and their children—to swallow. Bob Duthie, who founded the Nashville, Tenn., e-learning company Duthie Learning in 1989, realized 10 years ago it was time to start thinking about succession. As he took three weeks off to bring his boat from Lake Erie to Nashville, it occurred to him that the business was plodding along just fine without him—and someday, he’d have to step away for good.
His first thought was his two sons, both engineers who had started careers with big industrial companies. Like many business owners who want professional, outside input, Duthie hired a consultant to gauge the sons’ interest. His older son, it turned out, wasn’t interested. But his younger son, in his late 20s at the time, had grown weary of “the rat race” of the automotive industry and was ready to give the family business a try.
Andrew Duthie joined the business in 2000 as director of business development and was named president in 2003. Andrew expected, he says, that he’d run the business for 20 or 30 years before figuring out his own succession plan. Bob retained the title “founder” and kept responsibility for many of the client relationships, but also arranged to spend four months each year on his boat. Andrew’s new role was supposed to phase in over a three-year period, he says, but the reality was much quicker.
Soon, Andrew was immersed in running the business, devoting less time to the technical problems that lay within his realm of expertise, and expending more energy on management and sales—areas where he wasn’t as comfortable.
Business moved along without much incident until 2008, when the recession clamped a vise on business spending. Duthie Learning began to shed clients. For the first time, Andrew had to move money from the company’s line of credit to its checking account to take care of working capital. Andrew worried about returning to profitability. In August 2008, Andrew and his father held an emergency meeting, where they vowed to carry on. The company laid off several people, shrinking from 10 employees in early 2008 to five in early 2009.
Several months later, business was still excruciatingly slow. Andrew struggled with business development, and he wasn’t totally comfortable poring over the company’s financials. “We started thinking, ‘We are going to have to pull the plug or come up with a new succession plan,’” like selling the company to a third party, recalls Bob Duthie. Laying people off was particularly hard on Andrew, he says.
In the end, the prospect of bankruptcy was raised, but both father and son remained determined to avoid it. Instead, the Duthies struck a deal with a larger technology company in the area, which acquired Duthie Learning’s intellectual assets in September 2009.
Stick to Your Skills
If he were offering advice to other children considering taking over a family business, Andrew says, he’d tell them to focus on their core skill set and not take charge of areas that aren’t true strengths. “Figure out what you’re best at and find a way to ingrain your doing that into the company culture,” he says. If he were more adept at sales and marketing, Andrew Duthie says matter-of-factly, he, “would have been more inclined to stick it out.”
That’s why, Orion Capital’s Shroff says, it’s crucial for both parents and children to be honest with themselves and one another before the passing of the baton. The survival rate for family-owned businesses declines dramatically with each passing generation.
If the children aren’t passionate about the business, “it probably won’t work out,” says Shroff.
Often, he says, he has to take adult children into a separate room—away from their mother or father—for them to confess they’re not all that enthused about the prospect of running the family business. “Lots of people think transferring the business to the kids is best because they support the next generation,” says Shroff. But when high second- and third-generation failure rates are taken into account, “it’s not necessarily the best way to take care of them.”
From the White House to the Deep Fryer
Children who do take over the family business have to cope with sometimes-dramatic life changes. After more than a decade working in politics in Washington, D.C., Jimmy Christopoulos moved with his wife back to Grand Rapids, Mich., to take over his parents’ local chain of Mr. Burger restaurants, which they began more than 40 years ago after emigrating from Greece. He knew that his aging parents were ready to pull back from the company they spent a lifetime building. “I’d always had [taking over] in the back of my mind. But my dad had it in the front of his mind,” Christopoulos says.
His sister, who works in publishing in New York, and his brother, who works for the Chicago Mercantile Exchange, said they weren’t interested in the family business. And while Christopoulos “had a fulfilling, rewarding career” in Washington, he was growing tired of the relentless pace and of reporting to others. So three years ago, he returned to his childhood hometown to take over day-to-day operations of the six-store chain.
For now, his parents still own most of the company. Each of the three children is eventually expected to inherit a portion of the business, and Christopoulos collects a salary for his role as general manager. He’s gone from meetings on Capitol Hill and a stint in the White House to spending days in grease-laden kitchens.
In a world where changing jobs every few years is commonplace, many second- or third-generation owners may see the family business as a stepping stone, rather than a lifetime fulfillment, as their parents did. Indeed, though Christopoulos and his wife, a former chief of staff for a senator, are now settled into a decidedly different life in Grand Rapids, he still doesn’t necessarily see his role running the family business as permanent. “I don’t think there’s ever a final conversation,” Christopoulos says. Maybe in a few years, he adds, his younger brother will want to step back from his career and run the family restaurants instead.
In the meantime, he says, running restaurants isn’t that different from life in politics. “I have the job of a manager. An issue will come up, I talk to people, make a decision, solve the problem. That’s sort of what I did in D.C.”