Business Succession Planning: A Humanistic Approach

Mobile Estate Planning Council

September 20, 2016

For Educational Purposes Only

Presented by:

Jeffrey Winick, Senior Wealth Strategist

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HOUSEKEEPING

•The presentation will last 30-45 minutes, followed by 15

minute period to answer questions

•Part 1 Humanistic Considerations

•Part 2 Case Study

•If your questions are not answered, contact me directly or

a local member of the Regions Private Wealth

Management Teams in attendance today

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Business Succession: Statistics

Formal Written

Plan (9%)

InformalUnwritten

Plan(33%)

No Plan (58%)

Business Succession/Exit Plan**

Formal Written Plan Informal Unwritten Plan

No Plan

• 30% of businesses succeed in the transition to the second generation*

• 12% of family businesses make it to the third generation*

EXIT STRATEGIES

• Partner or other shareholders

• Third party, merge or be acquired

• Sell to a select management team

• Create an ESOP

• Gift or sell to family

• Liquidate company

• Do nothing – let heirs worry about it

* Family Business Institute

** ROCG Americas Consulting Business Owner Survey

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Potential Benefits of a Successful Business Succession Plan

• Improved communication and harmony with family, employees, customers and suppliers

• Commitment to future success

• Happier work environment with greater certainty

• Personal financial security and peace of mind

• Improves customer loyalty

• Reduces uncertainty and turnover of key management

• Helps key managers make decisions aligned with owner

• Increases the value of a business

• Provides banks/bonding companies greater confidence

• May help minimize income and estate taxes

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Business Succession: Understanding Your Choices

BusinessSuccession

InternalFamily Transfer

Employee Transfer

ExternalSale, Merger &

Acquisition,

Family Transfer: GiftSale

Combination

Employee Transfer: Management Buyout

ESOP Combination

Which exit strategy best accomplishes your business and personal goals?

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•Legal or tax strategies

•Estate planning techniques

•Gifting verses sale techniques

•Methods to create liquidity

•Valuation and discounts

What Today’s Presentation is Not About

What today’s presentation is not about:

What today’s presentation is about:

Personal considerations

preliminary to

Business Succession Planning

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Personal Challenges to Creating a Succession Plan

• Easier to maintain status quo

• Process complex and time-consuming

• Over-dependency on existing owner(s)

• Difficult family or employee issues

• Conflicting visions of owner and family members

• Overlapping skills/strengths

• Prior promises or entitlement issues

• Control/ownership expectations

• Misunderstanding of company value

• No committed timetable

Business failure is often not due to business or economic issues, but internal or family issues

Conflicts are frequently not about personalities, but about lack of structure and advance preparation for change

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“Typical Perspective”

LEGAL/TAX

PRACTICAL

FINANCIAL

“A Humanistic Perspective”

PERSONAL

PRACTCAL

LEGAL/TAX

FINANCIAL

Humanistic Approach for Business Succession

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• Core family and personal values

• Emotional - identity, pride, purpose

• Control and letting go

• Interpersonal dynamics

• Family, employees, vendors, suppliers, customers

• Friendships and personal relationships

• Employees

Humanistic Focus for Business Succession Planning

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• Personal future plans

• Spouse’s needs, concerns, point of view

• Perceptions and misperceptions

• Successor’s perspective and concerns

• Communication issues

• Readiness and preparation

• Owner’s business or personal legacy

Humanistic Focus for Business Succession Planning

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•Comfort talking about more difficult topics/issues

•Willingness to consider different perspectives

•Ability to facilitate communications

•Identifying important family/business dynamics:

• Sources of tension

• Emotional considerations and control issues

• Competing interests

• Perceptions of fairness versus equality

A Humanistic Approach Requires

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• Ability to facilitate discussions to overcome resistance to change

• Identifying tensions between the generations:

• Current leaders/owner(s) unwillingness to let go/step down

– Reluctance to take further risks

– Maintaining outdated approaches and processes

– Failure to expand technology

– Unwillingness to consider trends or expand services or products

• Next generation /successors pushing for change:

– Incurring unnecessary capital expenditures

– Failure to consider long term cash flow impact

A Humanistic Approach Requires

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• Recognition that owners:

• Are concerned about their employees

• Feel a sense of community

• Consider customers, suppliers, vendors, and lenders

• Care about their legacy

• Understanding that key employees or family members:

• May not be entrepreneurial & willing to take on personal risk

• Might not have the ability to successfully run the company

• May not share the owner’s vision for the company’s future

• Might not appreciate company culture and history

A Humanistic Approach Requires

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•Does owner(s) (and spouse) have vision(s) for next phase of life?

•Is traditional retirement appropriate or is there need to stay connected?

•To what extent is owner relying on business equity to fund retirement?

•Do you recognize relationships and tensions - family or employees?

•Do you understand the strengths and contributions of key employees?

•Is there a need to secure to add strengths from the outside?

•Do you know the details of any retirement plans and are they optimized?

•Do you fully understand the company’s culture and its importance?

•Do you realize company impact on the community?

Questions Advisors Might Consider Asking

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• Has ownership or control been promised to anyone?

• Are there non-active family/individuals who derive economic benefit?

• Are there expectations that ownership/position is guaranteed?

• Is there family/individuals who may later become active in business?

• Taken a different career path

• Raising a family is current priority

• Too young to anticipate potential

• Has the generation below been considered?

• Will successor(s) need internal or external help running the business?

• Is there a need to protect key employees, family, or others?

Questions for Owners/Leaders to Consider

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• Fairness verses equality?

• Should sweat equity be rewarded for prior and future contributions?

• Are there competing interests among family/key individuals?

• Are skills and abilities matched with what is best for the company?

• How do you view different contributions based on different strengths?

• What might be the impact of allocating unequal control/ leadership?

• Are there open communications among family/key individuals?

• How do you equalize between active & non-active family members?

Questions for Owners/Leaders to Consider

“At Facebook, we try to be a strengths-based organization,

which means we try to make jobs fit around people rather

than make people fit around jobs. We focus on what people's

natural strengths are and spend our management time trying

to find ways for them to use those strengths every day.”*

Sheryl Sandberg

*www.brainyquote.com

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• Memorializes company history and values

• Permits older generation to “let go”

• Empowers next generation to embrace the past to guide the future

• Considerations*:

• What are the central values of our family?

• How can family values strengthen the business strategy?

• How can family values be taught, preserved/institutionalized?

• What should be the family’s and business’s role in society,

including philanthropy, civic activities, and politics?

• How do we teach responsibilities of ownership to next generation?

• How do we balance expectations of family members, employees,

shareholders, customers, and the community?

Business Legacy Planning

*Family Meetings: How to Build a Stronger Family and a Stronger Business,

Second Edition, December 15, 2010, C. Aronoff and J. Ward

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Business Legacy Planning

Family Governance Issues

• Guidelines for entering family business

• Working outside first, timing, policies

• Where to start? Bottom or Mid-Level

• Standards for titles/advancement

• Criteria for salaries, bonuses, and future ownership

• Appropriate roles for family members who will not lead company

• Protect the “golden egg”

• Helps family establish and document core business values

• Creates a forum to develop a strategic plan for business succession

• Develops specific business goals with timetables

• Identifies benefits of having a business succession plan

Mission Statements

Family

Own Manage

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Qualities for an internal successor

• Ability to lead and motivate people

• Entrepreneurial spirit

• Good communication skills

• Ability to make critical decisions

Are future leaders being mentored and trained for their new roles?Are company roles aligned to match skills, goals, abilities?

Qualities an external buyer might possess

• Proven track record of experience and success

• Concern for current employees and customer

• Appreciates current company culture

• Compatibility if owner will have ongoing involvement

Are successors being courted and evaluated strategically? Could a merger or acquisition be appropriate prior to sale?

Qualities to Look for in Successors

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• Jim Smith, Sr. - “Senior” - is a successful entrepreneur and owner of Smith Industries,Inc. He is sole shareholder. Annual revenue is $80 million. Financial statement lists theCompany value at $20 million. There are 250 employees and 10 key employees.

• Smith industries is a top company to work for with average tenure at 12 years

• The Company has a 401k plan and excellent health and group insurance benefits

• Jim Sr. is married. Senior & Mrs. Smith are both age 60. They have 2 adult daughterswith son, Jim, Jr. - “Junior” working in the family business.

• During a recent meeting you asked Senior if he ever plans to retire? He respondedwith a frustrated “No” and went on to state how he wished he could start stepping awayfrom the business, but knows his business relationships drive revenue. Senior alsoshares he is getting pressure from Mrs. Smith to start slowing down

• A prior attorney from church has in place a Last Will and Testament for Mr. Smith whichcreates a Marital Trust for Mrs. Smith. Mrs. Smith and the three children are all Co-Trustees. At her subsequent death the Trust distributes equally outright to the children.

Illustrative Case Study

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Savings and checking $200,000

Marketable securities 1,000,000

Smith Industries 15,000,000

Jim, Sr.’s 401(k) 500,000

Investment real estate 1,300,000

Primary residence + lot 800,000

Vacation home 600,000

Personal property 500,000

Liabilities (900,000)

Total net worth $19,000,000

Smith’s Financial Situation

Jim, Sr.’s annual salary $300,000

Annual bonus/S Corp distributions 500,000

Investment earnings/rental income 100,000

Total Annual Income $900,000

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Typical Possible Business Succession Plan

Junior purchase stock

from Senior’s estate

Junior

Senior

Senior’s

Estate/Trust

Insurance

Company

Premiums

Death Proceeds

Smith Industries

Senior

Junior

Key-man policies

Senior and Junior

Financial Needs

Mrs. Smith

Junior, Jenny, and

Jill, Equalization

$

Junior purchases

policy insuring Senior

Senior’s

Death

$

$

Cross Purchase Buy-Sell Agreement

Coordinating Estate Planning Provisions

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• Junior’s experience level in the business

• Junior’s commitment to the company

• Senior’s perception of Junior

• Junior’s perception of Senior and of himself

• If key managers want to own equity

• Thoughts on external verses internal sale

• Other family or business dynamics

• The Smith’s financial needs in retirement

• Smith’s core values, attitudes, philosophy

What Don’t We Know?

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• Daughter, Jenny, is married, and homemaker with two teenage children. Her

husband works at the company as a mid-level manager, with no college degree.

• Jenny’s oldest daughter hopes to become a mechanical engineer. She is a sophomore in college, and worked in the company past two summers

• Jenny’s other daughter is in high school, and wants to become a teacher.

• Daughter, Jill, is single, and works as a physical therapist in another state.

• Junior is a newlywed with no children. He has been working alongside his father

for the past 10 years. He gave up the opportunity to go to law school to work for

his father, having grown up in the family business. He had thought about

becoming an attorney specializing in intellectual property law.

Additional Dynamics Within the Smith Family

What do these new details tell us?

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• Senior is a disciplined and values-driven man. His core values include integrity,

hard work, respect, and loyalty. He built the company on these principles. He has

considered offers to sell the company over the years, including a recent private

equity offer, but has rejected them for various reasons, including a strong desire

to maintain the culture of the company.

• Although Senior privately hopes Junior might be able to take over the company

one day, he wonders if Junior has entrepreneurial drive/leadership skills?

• Senior has never talked to Junior about his future with the Company, wanting his

son to freely make his own choices.

• Senior feels Junior understands and is committed to the values that have

contributed to the success of the family business, and he is confident Junior can

one day assume an executive position and serve on the Board.

Additional Information that Could Make a Difference

Why is this new information relevant?

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• Junior privately wonders about his future role in the company, but has never

approached his father to discuss. Junior also wonders if he has the skills and

motivation to run the Company, especially without his father’s ongoing guidance?

• Junior’s new wife regularly reminds Junior he promised he was not going to make

the same mistake as his workaholic father. He would always put family first.

• It has been your observation in meetings that Senior and Mrs. Smith have very

different points of view. Senior has shared with you in private his primary concern

is to provide for Mrs. Smith and to treat the children equally.

• Mr. Smith has expressed confidence in key employees, but thinks there is a need

to secure additional complementary skills to make an internal transition possible.

• Mr. Smith wants to also ensure he can retain certain key employees, and protect

those employees if he does side to sell to an external buyer.

Final Details about the Smith Family

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Other Planning Considerations

• Developing a management team to complement Junior’s strengths?

• Senior transitioning from day-to-day operations with specific target dates?

• Senior & Mrs. Smith creating an open atmosphere to discuss delicate issues, including estate equalization?

Key Employee Incentive Compensation

• Can executive benefits be a planning tool? [i.e. stock options, restricted

stock, performance bonus, deferred compensation, stock appreciation rights

(SARS), supplemental employee retirement plan (SERP)]

Non-Planning Considerations

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Estate Planning

• Should Junior’s past and ongoing contributions to Company be recognized?

• What does Senior mean by “treat children equally?” Fairness vs Equality

• How does Senior define “protecting” Mrs. Smith’s needs?

• Is protecting wealth for lower generations/creating a business legacy important?

• Could charitable planning strategies be helpful to attain family/business goals?

• Do we understand perspectives of Mrs. Smith

• Do we understand not just the Smith’s basic retirement cash flow needs?

• Have we considered the Smith’s philanthropic objectives, personal long term goals, and need to create financial buffers?

Non-Planning Considerations

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Partial company growthshifted from Mr./Mrs. estates

Smith Family Trust

Purchases (at discount)30% Non-Voting

Sale to Defective Grantor Trust

Recapitalize Smith Industries 10% Voting 90% Non-Voting

Key Managers

10% Non-VotingPurchase/ Incentive

Over time

Cash flow to Mrs. Smith then inheritance for daughters

Senior Retains

50% Non-Voting10% All Voting

Death of Senior and Mrs. Smith use to equalizeinheritances between Junior and daughters

Junior inherits, or purchases remaining voting and non-voting shares at Senior’s death.

• Purchase from Senior

• Incentive Stock Awards

• Stock Options

• Restrictive Agreements

Life and disability insurance could

provide liquidity to fund Buy-Sell

Installment Sale

Non-voting Stock

Senior sells or gifts voting and non-

voting shares to Junior over time

and/or sells to Management Team

Non-voting stock

allocation for

management

Buy Sell Agreement covers premature death & permanent disability. Possible Wait-and-See Agreement - keep flexible

Junior option purchase stock

Possible Succession Planning Recommendations

From

Treasury

StockProposed Result in 3-5 years

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• On December 1, 2016, Jim, Sr. has a stroke and passes away.

• Rumors start that the Company will be sold. Customers start doubting the Company can timely fill orders, and there is a business slow down.

• Three key managers at the Company give notice and take positions with a competitor. Other employees start looking for other employment.

• With no revisions to estate planning documents, Mrs. Smith and three children are named as Co-Personal Representatives and Co-Trustees of the Marital Trust created by Senior.

• Ownership of the Company remains in Trust exclusively with Mrs. Smith during her remaining lifetime. There are now four (4) decision-makers, each with different points of view.

• Junior continues to run the Company, but is frustrated knowing he will only inherit 1/3 ownership. He quickly starts to becomes resentful.

Epilogue with no Planning

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• Mrs. Smith dies 7 years later. With little liquidity the family struggles to pay taxes.

• Ownership is divided equally among Junior, Jenny, and Jill, including equal control

of Smith Industries.

• Jenny’s husband wants to play a more visible role. She also thinks her daughter,

mechanical engineer daughter should one day lead the company with her husband.

• Junior now has a 5 year old son Jill is also now married and has 3 year old twins.

• Junior questions if he should continue running the company’s day to day

operations, and wonders if his best option is to go to law school, finally fulfilling his

goal of becoming an intellectual property attorney?

• The Company is sold to Jones Industries, their biggest competitor, at half the

potential market value.

Possible Outcome with no Planning

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Junior worked side by side with his father for years, but never had the

conversation they needed to have about Junior’s future with Smith

Industries. What a difference if Senior and Junior could have shared their

mutual concerns and made business succession planning a priority earlier?

Might Junior have found the opportunity to express his self-doubt? Could

Senior have aligned key managers to complement Junior’s strengths, and

foster key relationships for Junior?

Senior might have found a way to equalize inheritances among the children

based on Senior’s and Mrs. Smith’s agreed-upon definition of fairness.

Junior’s interest in the Company might have been better protected had

Senior included key employees in the succession plan. Liquidity

considerations could have been addressed. With greater certainty around

business succession, confidence of customers, vendors, lenders, and key

employees, the future of the Smith Industries might have been secured

through a second generation and beyond.

Possible Alternative Outcome

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Final Thoughts and Tips on How to Approach Succession Planning

• Prompt conversations about core values, philosophy, and beliefs

• Understand how the owner(s)/leaders perceives key family members and

key employees who could play a role in business continuation.

• Determine the importance of maintaining the company culture

• Inquire to see if including those family members or key employees in

long-term planning discussions might be of benefit

• Encourage open communications to avoid misperceptions, false

expectations, and potential future conflicts

• Be a facilitator and proactive to prompt discussions about family

members, key employees, and capabilities and potential of each person

• Suggest including a spouse and understanding his or her point of view

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Final Thoughts and Tips on How to Approach Succession Planning

• Prompt owners (and spouse) to reflect on his or her next phase of life

• Determine to what extent leaving a business legacy is important, and if so

how it can be integrated into the business succession plan

• Look beyond normal projected retirement/next phase cash flow needs,

and try to prompt discussions about philanthropy, possible extraordinary

expenses, need for a financial buffer or financial security

• Understand to what extent business equity is being relied upon to fund

retirement or next phase in life cash flow needs.

• Know where wealth preservation and tax savings fits in as a priority

verses personal and legacy goals

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Who Can a Team Approach Help with the Planning Process?

IT’S A TEAM EFFORT!

• Your Banking Team (private wealth management, capital

markets, commercial or business banking groups)

• Estate and Corporate Attorney

• Certified Public Accountant

• Insurance Professional

• Business Valuation Expert

• Business Advisor or Investment Banker

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Questions

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Important Disclosure

This presentation is intended for educational purposes only and not

intended to provide legal or tax advice. Please seek legal or tax advice

from your attorney or tax adviser.

Investment, Insurance and Annuity Products

Are Not FDIC-Insured | Are Not Bank Guaranteed | May Lose Value | Are Not Deposits

Are Not Insured by Any Federal Government Agency | Are Not a Condition of Any Banking Activity