Succession Planning for Businesses: How to Avoid a Trip to Wonderland

I have to admit that I’m a sucker for a good, old fashioned sarcastic remark. I’m the type of guy who’ll actually compliment someone who directs a sarcastic remark my way, as long as the sarcasm is sufficiently artful. I admit that this is a little weird, but I think I can trace its origins back to one of the most sarcastic guys ever to put pen to paper, and someone who intimately understood the absurdities of life: British mathematician and novelist Lewis Carroll. Carroll, you may recall, wrote Alice’s Adventures in Wonderland (but to everyone except English professors, it’s just plain old Alice in Wonderland). One of my favorite passages from the book also happens to involve my favorite character, the Cheshire Cat. It goes something like this:

Alice:   “Would you tell me, please, which way I ought to go from here?”

Cheshire Cat: “That depends a good deal on where you want to get to.”

Alice:   “I don’t much care where . . .”

Cheshire Cat (grinning, no doubt):     “Then it doesn’t much matter which way you go.”

Alice:   “ . . . so long as I get somewhere.”

Cheshire Cat: “Oh, you’re sure to do that, if only you walk long enough.”

I can hear the wagering in the room now: “$50 bucks says there’s no way he connects Alice in Wonderland to anything remotely resembling a legal issue.” Oh, Grasshopper! Watch this:

Anyway, where was I? Oh, right. The Cheshire Cat. I like this passage as much for the Cat’s lethargic, disdainful sarcasm as much as for what the Cat teaches us about knowing where we’re going – and where we’ll end up if we don’t know: “somewhere.” Well, if “somewhere” isn’t good enough, then planning is required. This applies not only to a trip to the supermarket, but to careers, family life, business plans, and “succession planning” – which, conveniently enough, is what I want to focus on in this week’s blog.

So, what’s succession planning? Fundamentally, it’s deciding early on in the life of your company what happens to the ownership interests – the equity — if something happens to you or your fellow partners or stockholders. What could that something be? How about a decision by one of your partners to just stop working, for whatever reason (such as an illness, retirement, a lifelong desire to move to Bangkok, or just plain boredom). Would this leave your company in the lurch? Would the company be obligated to continue to pay distributions or dividends to a partner who just stops working? In the absence of a well-drafted succession plan, the answer is highly likely to be “yes.”

Or, let’s take another example. One that most people would prefer not to think about: the death of one of your partners, or your own passing. It’s not pleasant to contemplate, but the reality is that the deceased partner’s equity in the company lives on. Something has to happen to it. Succession planning will determine what that something is. Unless you would prefer for a probate court or your deceased partner’s last will and testament to determine who succeeds to her equity in the company. In which case it’s as likely to end up in the hands of her husband as her crazy sister who lives in an Ashram in Kathmandu. How would that affect your company’s operations and its cash flow? Better to avoid these possibilities altogether and come up with a written succession plan or agreement.

A well thought-out succession plan will determine what happens to each stockholder’s or partner’s ownership interests and rights in, as well as obligations to, the company in the event something happens. In the case of a corporation, the succession plan is usually made part and parcel of the Shareholders’ Agreement (which would make a good topic for another blog – making mental note to self). In an LLC or partnership, the succession planning language is generally included in the operating agreement or partnership agreement. In any case, it can also be a separate, stand-alone agreement if not included in either of these documents.

Most succession plans give the company itself, or the other partners or shareholders, the right (but usually not the obligation) to buy the departing (or departed) shareholder’s equity. It will also determine whether the company or the other partners have a right to buy out a seriously ill partner, or to oust a non-performing partner. The succession plan will also determine who else has a right to buy or inherit the equity in the event the company or the remaining partners decide not to buy it. And, perhaps most important, the plan will provide for a methodology for valuing the equity. Different types of businesses lend themselves to differing valuation techniques, which your financial advisor, accountant, and attorney (me, remember?) will discuss in order to select the proper valuation method.  Because the absolute worst time to attempt to value equity is when a partner dies or leaves. (By way of example, what do you suppose the odds are of arriving at an amicable agreement with your recently deceased partner’s sister with respect to the value of her equity interest? Which the sister now owns, incidentally.)

There’s much more to succession plans that I’ve touched on here, of course. But I think I’ve covered the major issues with a broad brush. A good succession plan will let you sleep easier at night. And the sooner you implement the plan, the more comfort it provides.

So, now that we’re all comfortable with succession planning and grinning like Cheshire Cats, let’s get down to business and make a succession plan. Before you end up “somewhere,” rather than where you want to be.

This entry was posted on Tuesday, March 18th, 2014 at 5:55 pm. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.