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How to get business succession planning right

Discover the various ways that succession planning for your business may help to create certainty and long-term vision for your company and its employees. Here, we consider why business succession planning is needed, even for small companies, and how best to keep the strategic goals of your business alive for the future with key insights and support from a specialist corporate solicitor.

Why is business succession planning needed?

Business succession planning refers to the plans that a business has in place to ensure that it has strategic and operational continuity if there is a change in key personnel, management, founders, or owners. It is common for a company looking to enhance its succession planning to engage legal advisers or management consultants to come into the company’s business and appraise and improve the company’s succession policy.

If a private or small, family owned company fails to plan for the continuity and enforcement of its strategic values by not making sure that the right people are engaged in its most valuable business roles (such as specialised operational roles or key management), then it will be difficult for the company to continue to meet its, and its shareholders’ goals. Failure to carry out suitable succession planning could result in the business losing value and assets if a change of ownership or leadership is not managed appropriately. Succession planning is a continuous process that should evolve with the business and its needs.

How to create a business succession plan

Different ways to exit the business

There can be different ways of exiting a business and each type of exit will influence the way in which the company is required to handle the succession. Key personnel can leave a company for many reasons, commonly including retirement, sickness, disagreement or resignation (either for a different type of lifestyle or job or perhaps a job in the same field with a competitor). For employees that are significant to the business, there may be periods of time written into their employment contracts in which they are not able to work for a competitor to protect the company for a limited time. Succession planning is not so much about what happens to the departing worker but rather what happens to the company after the departure. A company should be aware of its level of staff turnover and so should be able to prepare for and anticipate the need for new talent in key roles.

Challenges arise when a founder or shareholder wants to leave the company. If there is only one shareholder, this will mean that the company may be sold, but if there are other shareholders, there will be decisions to be made about whether a new shareholder joins the company or whether the shareholders left in the business want to buy the outgoing shareholder’s shares, or whether the shareholders as a whole wish to consequently sell the company.

It is prudent to set out the process around how a shareholder may exit the company in a shareholders’ agreement between the shareholders and the company itself. Whether or not the company may be sold or alternatively the exiting shareholder’s stake bought by the remaining shareholders, will depend on whether the business is looking to maintain or increase its operations and value. If a business is preparing to sell its company in the short term, then it will look to make decisions that will generate the most gains for the company now, rather than investing in long term projects. This could even mean structuring the business in a different way completely.  

How do you choose a successor?

Choosing a successor or a team of successors can be a daunting prospect for a company, its owners, and its management. A wise company will have programs in place to identify and develop talent so that the pool of internal candidates for a key role in the business at any one time is plentiful. A company can always recruit externally, and this can sometimes be useful when the organisation is looking for a clear change in direction and fresh ideas. Internal recruitment has the benefit of consisting of well-known candidates that have been raised on and bought into the company’s mission statement and who understand the company’s culture, which is important if the goal is to preserve parts of the current strategy or status of the company.

A company’s leadership should make sure that they invest in training additional people to perform specialised operational roles and key functions in the business so that the company is not reliant on a small pool of talent. It is also worth ensuring that responsibility for the company’s growth is given in appropriate ways to all levels in the company structure. With that responsibility however should come the chance to influence how the company is run in the future and a company could look at ways that its future talent could contribute to the company’s overall vision, as part of its succession planning.

Making sure that your company can assess the performance of its workforce is also important as it will enable the company to be seen to highlight talent transparently and fairly in a way that is logical and based on quantifiable metrics. There is clear value in a company making sure that employees know how to progress and being able to identify and target milestones as this can foster commitment and motivation within a company’s workforce.

Valuating the business

In order to accurately value the company and its business, the company’s management and its advisers will need to have built an analysis of the current business and its environment in order be in a position to assess how to preserve this value and increase it in the future. A company can do this by engaging valuation experts to assess the value of its tangible and intangible assets and liabilities and its hypothetical cash price that a willing buyer and seller would agree to if they both had knowledge of all of the relevant facts of the company (called the ‘fair market value’).

Sometimes valuations can be made using other calculations such as the value of the business to an interested investor or if the business is not performing well and is no longer viable, a valuer may look at the value of liquidating the company and selling off its assets separately. A valuer looking at a company will also consider the history of its earnings, its net worth, its income and its costs, the industry it is in and the market share it holds in that industry, as well as the general economic conditions or trends at play at the time of valuation and the company’s capacity for future growth.

Once a company has a handle on its perceived value, it can look at how that value has been generated and find ways to maximise the value increase. Valuation may also be necessary if a shareholder is leaving the company and wants to take part of the value of that company that it is entitled to with it as consideration for the shares it is selling.

Choosing an appropriate company structure

Business succession planning may also include looking at different corporate structures to better suit the growing business. In England, the following companies are governed by the Companies Act 2006:

  • A company limited (where the liability of its members (the people that own the company) is limited) by way of shares, which means that a member’s liability is limited to the amount as yet unpaid on the shares held by that member. This can be a public or private company; or
  • A company limited by way of guarantee, meaning a member’s liability is limited to the amount that they have agreed that they will contribute if the company goes into liquidation. This can be a private company; or
  • An unlimited private company where there is no limit on the liability of its members – these members could then be responsible for all of the obligations and liabilities of the company.

A company is a “public company” if it has chosen to raise capital by offering shares to the general public. It has limited liability and its shares are available to be bought or sold by a range of people in a range of ways. The company’s certificate of incorporation also must state that it is a public company. The Act states that a company is a “private company” if it is not a public company. A limited company can also become a community interest company which are companies that often carry out work of a social or benevolent nature.

Limited companies can be good investment vehicles, as they can offer limited liability to investors and can make doing business with third parties and funders easier as companies incorporated under the Companies Act 2006 are often seen as more accountable than sole traders or some partnerships to risk adverse contracting parties.

Buying and selling limited companies is a well-known commercial activity and there is an active global market for such transactions. Business succession planning might include changing a private company to a public company (or vice versa), or might see a private company putting in place a shareholders’ agreement so as to effectively set out rules for what happens on the exit of a current shareholder or the addition of a new shareholder. A company may also look at the classes of shares that it holds and think about creating new classes of shares with specific rights (such as voting rights) to accommodate future investors. For similar reasons, a company’s board may look to disapply any pre-emption rights for new shares for a certain period of time to make the process of future shareholders joining the company easier.

Choosing the right corporate structure for your business will also depend on the financial needs of your business, efficient tax structuring, its appetite for risks and exposure to liabilities and how much debt your business has acquired or is looking to acquire.

Do you need to raise any additional funding for business succession planning?

Whether or not you will need to raise any additional funding for your succession planning will depend on the financial status of your business, whether succession planning has been incorporated into your budget and whether the future plans you have require an injection of finance above an amount readily available to your business (for example, through the company’s own reserves or its wider group structure (such as a shareholder loan)).

If a restructuring or sale forms part of your succession planning, then it could be that extra cash will need to be raised through third party financing or equity financing as necessary. In theory, a company has a range of funding houses to choose from (such as leasing companies, commercial banks and private equity funds) that will be able to provide the company with debt financing which is financing like loans or other types of lending such as overdraft arrangements.

If alternatively, a company would like to raise cash through equity financing (this is the selling of its share capital), the board of the company will need to approve the sale of the shares (or classes of shares) in the company. The Companies Act 2006 specifies how and when both a public company and a private company can sell shares and legal advice should be sought from a specialist corporate solicitor before a company begins this process.

What agreements do you need to think about?

Succession planning that involves a company with share capital should make sure that the company has set out its exit strategy in both its articles of association and in a more detailed way in a shareholders’ agreement.

Typical exit provisions in a shareholders’ agreement will take into account the processes involved if a shareholder leaves or a new shareholder wants to join, including for example:

  • What value an exiting shareholder is entitled to
  • What value a joining shareholder should contribute
  • Whether remaining shareholders can buy out an exiting shareholder
  • And if so, whether the exiting shareholder first has to offer its shares to the remaining shareholders before it can sell them to a third party

This is designed to make sure that the other shareholders have and the company itself has an element of certainty that the status quo of the company will be maintained unless all the shareholders (or a majority) agree otherwise.

A business that is set up with more than one owner can also enter into an entity-purchase arrangement. This agreement is an insurance policy taken out and paid for by the business itself on the lives of the owners of the company in the amount equal to each owner’s interest in the company. On the owner’s death, the business will purchase the owner’s shares with the money it gets from the insurance. This type of policy may be suitable for small, family run private companies as it will enable an owner to make sure that its stake in the company will be paid out on its death to its estate and that the business will be able to continue.

How to prep the team for the transition

It is important to involve the stakeholders in your business at an early stage of succession planning.  Having a clear idea about the vision and goals of the company and the founders or owners of the business will enable the team to work towards a common strategy. Any business succession planning should also highlight areas of the business that need to be focused on to ensure that they are able to continue to perform well after a transition. Clear and transparent communication is therefore key as well as running the succession planning as a formal process with targets and goals. You essentially need to make sure that the team managing the company post-transition have bought into the company’s thinking and direction. A good way to do that is to give the team the ability to contribute to the company’s development (and possibly restructuring) in a meaningful way before the transition occurs. It will then be important to make sure that those team members that require training in either specialised operational roles or management roles are supported and given access to the departing personnel (to the extent possible) to ensure a smooth handover.

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