Chapter 3
Making the decision

In the previous chapter, you left everyone sitting around a table ready to discuss the long-term future of your company, including succession planning. Now that you have everyone at the retreat, it’s time to decide what is important to you, your family and the business – in other words, a vision of the future. This is the meeting to discuss goals, timelines and how long you want to be active in the company.

Remember, all parties must buy into the plan for it to be successful. All parties must understand their role in developing the plan and implementing it. The plan should be your reference guide to the future, your road map. You may have a couple of sessions to make sure that the group dynamics are right, one session with only insiders and one session including advisers.

For a partial list of questions and issues to consider, see Exhibit 1 on page 15. Some of the questions in Exhibit 1 will be discussed in later sections. The Ownership and Management Succession Issues from the exhibit are relevant here. The answers to these questions will begin to form your plan.

But first, to frame your analysis, you can group your options into three critical levels:

• Legal options. This refers to how the wealth of the business will actually be transferred (e.g., gift, annuity, buy-sell agreement, partnership, etc.). It will be the final “legal” transaction of the business under your control.
• Funding options. This refers to how the transfer will actually be funded. There are many ways to structure a financial transaction (self-funded, insurance, cross purchase, working capital, public offering, etc.). What will work best for you given your requirements?
• Managerial options. Who will ultimately be responsible for leading the business? What structure will be established? Will there be more than one leader? How will the owner transfer their knowledge over to the new leadership?

The legal, funding and managerial options will be discussed throughout the rest of this book. There is a specific chapter on “structuring” where some of the legal options will be discussed. The final chapter discusses the financing of the plan. Finally, the managerial options will be discussed in the next chapter on grooming a successor and in other places in the book.

Your five basic options
In the end, using whatever legal, funding and managerial options you choose, the business can only be transferred in one of five ways:

1. Leave the business to the family
2. Sell to a third party
3. Sell to employees
4. Take the company public
5. Close the business

We will discuss each of these alternatives in detail in the coming chapters. For now, you must develop the criteria to evaluate each alternative.

Consider other owners. For simplicity sake, this book assumes a succession plan involving a single, active owner. Often, however, there are multiple owners. In those cases, you need to adjust in a couple of ways. First, there must be a buy-sell agreement, which is addressed in Chapter 16. Second, consider the other owners in context of your review of the five basic ways to transfer a business. Remember that succession planning is about transitioning both ownership and management and that they are not the same thing. If you are close to the other owners, you may want to consider them family or key employees for purposes of succession planning. On the other hand, if the other owners are silent, consider them as third parties – albeit third parties that already hold stakes in the company. Going public or closing down are unique decisions that any ownership group would consider.

Make succession planning flexible. When developing the criteria to evaluate your alternatives, keep it flexible. Things change. You may face unexpected health problems, successors who don’t get the big picture, or even major industry changes. The best thing to do is keep it simple. The fewer formal documents, the better. Spend more time discussing the strengths, development needs and career plans of possible successors. Open and clear communication is clearly the best route.

Keeping it flexible and simple does not mean abandoning good principles. A written plan is the way to go, and legal documents are essential; just don’t kill a forest doing it. Basically, a succession plan is merely a communication on how you will exit and what will happen to the business.

Determine objectives. The hardest part of the whole process is nailing down precisely what you and the other stakeholders want to achieve. There are hundreds of possible objectives, but the one that, unless you are totally selfish, certainly will not work is maintaining the status quo. There are only two certainties in life: death and taxes. If you choose to do nothing, you will at some point die or become incapacitated. If you love those around you, then you will want the business to continue to provide your other stakeholders with the benefits of owning the company like you did.

Keeping in mind that there are numerous objectives possible, Exhibit 2 will help you get started. (See page 16.) Any question you may add is fair game, so add to it. Again, your final set of objectives is the single most important step in the process.

Research your options. Read the rest of this book and come back to this spot. The remaining chapters of this book outline what to do once you decide your succession plan and the issues involved for you to consider in making your decision. Research each option as if it were your preferred choice. That exercise will help you come back to this point with the confidence that you have considered every possible angle.

A systematic analysis
Once you have your objectives outlined and thoroughly researched, there are two ways to systematically evaluate the five alternatives based on your objectives.

The “stop light” approach. If you are a qualitative person and want to do more of a “feelings” approach, then the “stop light” option is best for you.

Here is how it works. The “stop light” chart allows you to weigh each option against your priorities. Across the top of the page, list options 1 through 5. These represent the five ways to transfer the business as listed on page 11. Down the first column on the left, list your criteria based on the objectives from Exhibit 2. Categorize the objectives from Exhibit 2 in whatever fashion you desire, then list those criteria. The example below categorized the criteria into seven areas. Finally, rate each option using a “stop light” approach. Green means that option and criteria are OK. Yellow is caution and red is a stop. If you rate a criterion as red for a certain option, then serious thought should be taken before proceeding with that chosen option.

After you finish your “stop light,” review the results and circle the option with the most green lights and the fewest red lights.

The worksheet approach. If you are more of a numbers person, the worksheet below is probably better for you than the pros-and-cons approach of the stop light. The key to using this succession alternative worksheet effectively is to develop appropriate selection factors and assign them proper weights. This procedure provides flexibility because the factors can be few or many.

Assisted by your adviser, establish the major factors that will influence the selection of the succession alternative. In this example, management selected four major factors:

1. Owner’s personal preference
2. Family preference
3. Employee satisfaction
4. Best tax result

Management then ranked each factor in order of importance and assigned it a weight, from four points to one point, as shown in column B of the sample worksheet.

Using objective and documented analysis, evaluate and rate each succession alternative on a scale of one to 10 points (with 10 being the highest rating possible) for each of the major factors. In the example, the point ratings are on the left side of each alternative factor block (columns C through G). For example, the owner gave the leave to family succession alternative a rating of nine points because it was the owner’s preferred alternative (see block C1). However, this alternative was the one least preferred by the family and employees. Consequently, the owner rated it one for these selection factors (see blocks C2 and C3).
Each point rating is multiplied by the weight in column B to produce the scores, shown on the right side of each factor block (columns C through G). Add up the totals for each column, and the higher scores usually indicate the preferred alternatives.

Scores resulting from this evaluation technique provide only approximate comparative values. You should review the results of the evaluation and make the final decision.

After you finish the intensive process of determining your succession plan requirements, you must prepare the business for transition. For example, suppose you have decided to pass the business on to a family member. In all likelihood, that person needs some development before he takes over the reins. You might even want him to work somewhere else so that he can get experience outside the current environment, in which he necessarily is a subordinate to you. Next we discuss how to groom your successor, followed by a more in-depth discussion on the five ways to transfer the business.

Exhibit 1
List of Planning Considerations

Ownership succession issues

1. Is the owner willing to transfer a controlling interest in the business before his or her death?
2. If the business has more than one owner, do the owners have a buy/sell agreement in place? If no, why not?
3. Does the owner have children who are interested in acquiring the business when he or she retires?
4. Do the owner’s children have the resources necessary to acquire the business?
5. Does the owner want all of the children to own an interest in the business?
6. Does the owner want all of the children to have a voting interest in the business?
7. If no children are interested in owning the business, has a buyer been located?
8. Who will acquire ownership of the business if the owner dies before retirement?

Management succession issues

1. How long does the owner intend to remain active in the day-to-day operations of the business?
2. Who does the owner want to run the business when he or she retires?
3. Is there someone capable of running the business in the event the owner dies prematurely?
4. Are the owner’s children currently capable of running the business or acquiring the skills necessary to do so?
5. Are there key employees who are capable of running the business?

Retirement planning considerations

1. Will funds from the business be a major source of funds for the owner’s spouse and dependents?
2. To what degree is the owner willing to finance a sale of the business?

Estate planning considerations

1. Is life insurance necessary to ensure the financial security of the owner’s spouse and dependents?
2. Does the owner want to minimize (or eliminate) estate taxes at his or her death?
3. Does the owner want all children to receive an equal amount of wealth at his or her death?
4. Must all children receive an equal interest in the business?
5. Will assets be transferred to the surviving spouse outright or in trust? If in trust, is trustee authorized to and capable of administering ownership in the business?
6. Is the owner willing to make lifetime gifts to reduce his or her taxable estate? If so, does owner understand that incurring gift tax may be inadvisable in light of the repeal of the estate tax, effective in 2010?

Exhibit 2
Goals Clarification Worksheet

Client: ______________________________________ Date:_________________________

Instructions: The sample goals on this worksheet are a starting point from which customized goals can be stated. In the case of married clients, both spouses should have input into the goals clarification process. This may be accomplished by both spouses completing one worksheet together, or by each one completing a separate worksheet.

Please check the lines before the goals the planner should consider in this engagement. Personalize the goals as desired. Indicate the priority each goal has relative to other goals selected by circling a number to the right of the goal.

MANAGEMENT SUCCESSION
__1. To transfer management control in (number) years.
__ 2. To transfer management control to (name).
__ 3. To divide management responsibilities between the following (names of individuals).
__ 4. Other (describe):______________

OWNERSHIP SUCCESSION
__ 1. To transfer ownership in (number) years.
__ 2. To transfer voting ownership to (names of individuals).
__ 3. To transfer nonvoting ownership to (names of individuals).
__ 4. To prevent outsiders from acquiring ownership.
__ 5. To ensure my associates will acquire my interest if offered for sale.
__ 6. To ensure I can acquire associate’s interest if offered for sale.
__ 7. To minimize income taxes on the ownership transfer.
__ 8. To receive fair market value for the ownership interest (if sold to family member).
__9. To maximize cash received (as opposed to accepting buyer’s note) on ownership transfer.
__ 10. To reduce my exposure to business liabilities.
__ 11. To avoid gift tax on transfers.
__ 12. To retain the following key employees (names of individuals).
__ 13. Other: _____________________

WEALTH TRANSFER GOALS
__ 1. To provide financial security for my spouse.
__ 2. To divide my estate equally among my children.
__ 3. To reduce or defer estate taxes.
__ 4. To gift interests to family members.
__ 5. Other:________________________

RETIREMENT AND FINANCIAL INDEPENDENCE PLANNING
__ 1. To provide financial independence and adequate resources for retirement years. Assume retirement at age ___ on (date).
__ 2. To have an income of $______ per year after retirement at age ___ or beginning (date).
__ 3. To retire by (date).
__ 4. Other:_______________________

BUSINESS GOALS
__ 1. To ensure business stays in my family.
__ 2. To minimize the business disruption.
__ 3. To minimize the use of business cash flow for taxes and expenses.