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Legal Experts Share Secrets to Successful Succession Planning

Finding the right timing to announce a succession plan may seem like a major challenge. But how a plan is drafted and executed is extremely critical. Here, Attorneys James Spoden and Craig Shamburg of MacDonald Illig in Erie, Pennsylvania, discuss some of the key areas that employers need to consider when developing an effective business succession plan.

Succession planning is critical to the future of businesses. However, it is not merely about appointing a successor, but also planning to avoid potential issues. Please explain.

A successful plan requires a business owner to first evaluate his or her financial plan and estate plan and then conduct an honest assessment of the type of transaction he or she is considering. Business owners are looking to transfer their business to family members, co-owners, employees, third parties and possibly no one. In some cases, succession or sale is unavailable and the business owner chooses to liquidate.

Is succession planning the same as exit planning?

Succession planning may or may not be exit planning depending upon who is the successor. A sale to a co-owner likely will result in a business owner’s exit. Transfers to family members or employees often involve some continuity of organization and a transition plan that requires the business owner to remain a part of the transition process. Sales to third parties, whether a strategic buyer or financial buyer, often involve transition agreements and employment or consulting agreements for a limited period of time following the closing.

In some cases, financial buyers also want the business owner to retain a partial investment in the business to ensure its orderly transition and success.

What enables a succession plan to succeed?

A sale to a third party often succeeds because the business owner is able to convert his or her business investment into cash proceeds; and, if that is the objective, success is assured with  careful  planning and execution. Sales to co-owners have a similar outcome. Sales to family members or employees, whether they take the form of a cash sale or more often some type of deferred payment, succeed if the family members and/or employees who succeed to the ownership and operation of the business are prepared and qualified to undertake those tasks. A transaction that is not overleveraged and thoroughly vetted is also more likely to succeed.

What legal issues need to be addressed?

The legal analysis starts with the current organizational structure of the business, its bylaws, shareholder agreement or operating agreement to determine the legal obligations of the owners. The documents may need to be amended to address the type of transaction being undertaken. An acquisition transaction for sales to third parties, co-owners, employees or family members will need to be negotiated to provide the business owner and purchaser with comprehensive representations, warranties, covenants and remedies to protect both parties. It is usually helpful to enter into a non-binding term sheet, a letter of intent or outline of the transition plan to be certain that all parties have a common understanding of the transactions before significant costs are incurred.

When is the best time to start thinking about succession issues?

Now. Every successful business has a strategic plan and depending upon the business owner’s age and financial wherewithal, business succession or transition planning is both a work in  progress and forward looking. Preparing family members and employees, and communicating goals with counsel  are critical to the business owner achieving his  or her transition vision. Achieving financial success independent from the business and establishing a retirement and estate plan will enable the business owner’s vision to be achieved.

Is there anything you would like to add?

There are no guarantees that a business owner’s transition or succession plan will succeed. There may not be family members who are interested or capable  of  running the business. Co-owners may lack liquidity and market factors may reduce negotiating leverage and sale price in transactions with co-owners. Employees frequently are not ready or able to run a business and have limited access to capital. Third parties may be difficult to find. There may not be strategic buyers such as customers or suppliers that are interested in acquiring your business and sales to private equity are often more challenging and place limits on the business owner’s ability to exit at closing.

A long-term business plan and deeper conversations with advisers and family members are necessary to achieve goals and objectives that most business owners  hope to achieve. Every situation is a little different, and it is difficult to generalize or identify one path for all businesses.