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Transitional Timing for a Generational Change in Ownership Can Be Key

T.S. Eliot was a famed twentieth-century British poet known for insightful quotes. My personal favorite is: “This is the way the world ends, not with a bang, but a whimper.”

Everything ends, and perhaps its corollary is that “change is inevitable.” So it goes with family business transitions. Generational transitions are difficult at best and creating successful transfers of power and wealth requires careful planning, coordination and timing. Transitional timing can be the key to success – or failure.

Death, disability or illness can dictate the timing, but in all fairness, it isn’t the norm (although contingency plans should always be in the wings). This discussion is about planning and timing that is typical, predictable and controllable. Those who work with family businesses find that generational transition patterns will repeat themselves. The pattern developed by founders (G1) to the second generation (G2) will establish the protocols for generations to come. So let’s focus on the G1 to G2 transition hoping that doing it right will pay-it-forward.

Each situation is unique. However, there are “best practices” that need to be addressed and implemented if they fit. There are also some practices that have become commonplace that may be counterproductive.

Semi-retirement
The “slow down” phase of a G1’s career is commonly referred to as semi-retirement. Looking at various definitions it is unclear if it is part-time retired or part-time work.  What is clear is that semi-retirement lacks any universal clarity. One advisor defined it as less work and more pay because leisure time costs money.

Semi-retirement is an unusual position in the working world. It is a concept that applies to very few and it is usually reserved for professionals who cut back working hours or business owners that can maintain operations with reduced hours often from a distance. We think of semi-retired snowbirds who migrate for the winter months and work to a limited extent for the rest of the year.

Technology has allowed more connectivity from a distance so that management efforts can be accomplished from anywhere at any time. Consequently, semi-retirement is no longer weekly check-up calls from a landline, but electronic conferences whenever and where ever desired.

While the semi-retired usually get to make the rules (them that has the gold makes the rules), those on the other end find it very problematic. You never hear the titles “semi-CEO” or “semi-president.” Before technology interfered, semi-retirement for the big dog was a good training ground for the litter they left behind. Now the technology doesn’t allow even a semi-CEO any real empowerment on a part-time basis. When a semi-CEO makes a decision without consultation that the semi-retired CEO questions, the second-guessing begins, and the transfer of power and authority become derailed.

Moreover, the timeline for semi-retirement has changed. A generation ago it was 5-10 years. Now, due to longer healthier living, it’s more like 10-25 as people work and live longer.

The Money
For many business owners either the equity in their business or the ability to continue compensation through the business, is their retirement funding. It is doubtful they would leave their funding mechanism to chance by losing control. If the senior generation can’t sell the business for cash to fund retirement and has insufficient outside assets, they will need continued compensation.  It is uncomfortable to be in a position of needing retirement funding and relying on a Promissory Note executed with one’s children. Even “Claw-Back Provisions” within that note allowing parents to regain business control upon certain non-performance guidelines fails to solve the problem for several reasons:  retired parents aren’t interested (or maybe capable) of re-engaging in the business, the business may be in such poor condition that revival is unlikely, or invoking the claw-back would invoke family discord.

Generally, the children don’t have the wherewithal to buy the business outright – either on their own or with funding from third-party lenders.  (Sidebar: there are investors who specialize in funding this type of transition, should that become an option.) Hence, the semi-retired solution where seniors fund retirement through compensation while retaining ownership control.

The Rules
The unspoken promise when a child enters a family business of “one day this will all be yours…” appears broken in semi-retirement. The child’s inner voice is questioning the decades of hard work, the career decision, and their future. The when, if ever, and how questions loom large. We have seen future generations exit for other opportunities or retire before their predecessors. My experience is that four years into semi-retirement things tend to get dicey. Sending EFTs (EFTs used to be checks) as compensation to nonworking employees is highly irregular. Owners typically get rewarded by profit distributions, or an increase in asset value, but not with a paycheck.

For semi-retirement to work everyone needs to be on the same page. Once the seniors begin to take extended time off and remain on the payroll a rulebook should be written. Those rules should contain revised job descriptions, updated titles and restructured compensation. There should be a clear path for how profits (or losses) will be handled. There should also be a plan in place for ownership transition – a how and when (even if the “when” is handled through an estate plan). In the past, estate tax laws dictated much of the timing and waiting for death made financial sense. Current tax laws have rendered that waiting period obsolete for most. In any case, a timeline is a critical piece.

The rulebook should be a multi-party negotiation. It should include all the key stakeholders – both those working in the business and those inactive but part of the equation like spouses or siblings with estate interests. The board should also be party to the plan as they should be the watchdog making it all work. Annual reviews of the plan should be part of the rulebook. Outside professionals should be used to guide the process because they can offer experience and expertise to expose potential issues and offer solutions.

Timeline
Deadlines, when they are taken seriously, work for getting things done. That’s why the rulebook needs a timeline. The timeline should have an END for the senior’s involvement and a decrease in their power and authority along the way. They should change positions from president to ambassador. Often the title and role become “Chairman of the Board” where G1 can remain involved – at a distance – and yet offer experience and wisdom in an appropriate style. That assumes you have an active board (of either directors or advisors), and if you don’t, you should set that up today!

It should go without saying that G1 needs to find activities outside the business or all the best planning in the world will likely disintegrate.

There also needs to be a concurrent management succession plan with a synchronized timeline. This critical aspect of transition planning is regularly overlooked. As G1 slows down, holes in management are created and they need to be filled.

Exit
One way or another everyone leaves a business – change is inevitable. Business owners with control get to make the rules. They would be wise to be collaborative in writing that rulebook and be sure to make it transparent. While it isn’t the world ending, it would be best to go out with a whimper.

Richard Segal

Rick Segal is the principal at Segal Consulting. He holds an Advanced Certificate in Family Business Advising with a Fellows status from the Family Firm Institute. Rick is the founder of the Family Business Council and its affiliated study group. Reach Rick at [email protected] or by visiting www.segalconsulting.biz