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Succession: Don't leave it too long

Whether you’re the HR manager in a large corporate considering who is next for promotion, or a SME director looking to retire, having an effective succession strategy is essential, says Jai Breitnauer.

By Jai Breitnauer | June 8, 2017 | News

About eight years ago, during the global financial crisis, my husband was made redundant, and he did what any self-assured thirty-something would do with a meaty severance package – he launched his own firm. Admiration from suitably impressed friends rolled in. Then, he got a phone call from his step-dad, a seasoned businessman.

“I hear you’ve started your own business, boy?” he said, and my husband waited for the usual praise, but instead he got a question.

“What’s your exit strategy?”

Well, what is your exit strategy?

To say my husband felt silly to not have any real answer is an understatement, but the truth is, many people run head-long into launching, buying a business or becoming part of a franchise without any real idea where it’s ultimately going. That’s understandable – your early focus is on building the business and revenue, but it’s a truism that has many professionals who advise SMEs banging their heads against the wall.

“Too often business owners are so busy working in the business that they don't have the time to work on the business,” says Katrina Hammon, associate at Duncan Cotterill. She and her team of solicitors spend a lot of time advising clients around succession planning as part of a wider business strategy.

“Lack of succession planning is common,” Hammon says. “A good lawyer will remind their clients of the need to prioritise succession planning. [It] should be an ongoing agenda item for business owners, not left until the year you want to exit or when illness or another unexpected event occurs.”

Succession planning is about playing the long game, and it’s key to your business success. Imagine, for example, a game of chess where the king represents your business, the owner or director is the queen, and the other various pieces are the employees, suppliers, infrastructure and market challenges. Your game is based around clear strategy, and although that strategy may adjust to the game as it is played, your ultimate goal is to keep the business – the king – from harm. This may mean moving your bishop (your HR officer) into a more strategic role, or it may involve sending a knight (your business development manager) out on to the board. Ultimately it may also mean that you, the queen, has to step aside and allow the other supporting pieces to take lead roles protecting the king.

Now imagine that chess board again, except on your side of the board, there is just you and the king. If you run a business where you are the HR officer, the business development manager, the accountant, sales and logistics coordinator and the tea boy, then your position is weak. If you are struck out, who is there to step in and protect the business?

Effective business management is effective succession planning

Professor Joe Bower from the Harvard Business School spent some time considering what he calls the ‘corporate value-add’.

“All of a sudden it occurred to me that one of the things that was most closely associated with the creation of real value sustained over long periods of time was management of succession,” said Bower in an interview about his book The CEO Within.

“As soon as you say it, it is pretty obvious that if you continue to have good leadership, that’s going to be very important to a company.”

One of his critical findings was that the way you manage succession is basically the same way you manage a company. “Companies that are able to manage succession well have been investing in the development of leaders, of their people at the same time that they’re developing businesses,” says Bower. “It’s very hard to have a successful business without great people running it.”

Geoff Hamilton from SME Financial in Auckland calls this having a ‘sale-ready’ business, and says one of the most common factors that devalues a business is too much dependency on the owner.

“If the owner is so important to the business they’re limited to being able to sell to someone like themselves. They’re not going to be able to sell to an investor who wants to buy a business that will operate itself and produce a passive income.”

Hamilton says a good business will have systems and processes in place so the business can be run by the staff with the owner absent. This will ultimately increase the value of the business to a prospective buyer, or make it easier to hand the business on to children who don’t necessarily have the right skills.

Succession planning early can also assist business structure and growth - something Hamilton believes is hugely overlooked.

“People get so involved in the everyday, every decision, micro managing, they haven’t put their head above ground to see how they could organise things so they don’t have to be there all the time,” says Hamilton. “I ask business owners, if they freed up 20 hours a week, how much more new business could they generate? Usually SME owners say, ‘We could double the turnover!’ so why don’t they get someone in to give them that 20 hours? Because it means they have to go without things.”

Hamilton notes that businesses with good cash flow often invest in the trappings of success, like a new car or the latest mobile phone, when they should really be investing in training and developing staff, and on infrastructure.

Succession is about having options

It might seem bleak to be thinking about what comes at the end, especially if your business is quite new, but having an exit strategy isn’t necessarily about retirement or dying.

“Succession planning could be partial sale, or stepping away and drawing a salary,” says Harry Ferreira, head of small business at BNZ. “Many businesses we talk to, the succession planning is the management of the business and ownership.”

Ferreira notes that those are actually two different pieces that don’t necessarily have to be treated the same.

“You can have an ownership structure which is part of your succession planning, and a management succession plan,” says Ferreira. “The ownership of the business could be passed on to family whilst the original owner could draw a salary into the future and the management succession planning could be part of how your operations work.”

Ferreira says knowing your options is part of the reason it’s so important for businesses to consider succession planning well ahead of time.

“In our experience, we also see very different transaction styles between cultures,” says Conor McElhinney, partner at McGrathNicol accountants and head of the New Zealand retail advisory team.

“The typical Western style is to transfer the business at market value, with the next generation generally funding the purchase by taking on debt. This can leave the business highly geared, limiting future growth as profits are used to service debt. Other cultures often gift the family business to the next generation and receive a stipend from the business for the rest of their life. [There is no gift duty in New Zealand]. This enables the next generation to grow the business from retained profits, rather than using profits to service debt.”

Being open-minded to the options available can not only assist the sale or transfer of the business, but service your own interests as you move on to new ventures. But to have options open, your business structure has to be right.

Structuring succession

For example, imagine you had 12 corner dairies. You want to sell the six highest performing stores and gift the other six to your children while still drawing a salary.

“[Splitting the business] can be easily managed if the business structure has been set up with this in mind – [with], for example, a separate entity operating each location,” says Duncan Cotterill's Katrina Hammon. “The entities would be a subsidiary of an overarching company and the accounts and contracts for each business held separately.”

Hammon says there may be other asset protection and tax benefits for holding stores in separate subsidiaries.

“This is a great example of why you should take time out of the business to review the succession plan and that includes the structure of the business. If changes to the ownership structure need to be made, that can be done prior to the proposed sale of some or all of the businesses.”

McElhinney notes that an effective group structure allows for flexibility to change the business in the future.

“For example, if you owned 12 dairies, it would be sensible to hold each dairy in a subsidiary entity with all contracts executed by the subsidiary and with separate accounts being maintained.”

It would also protect your other 11 stores should a claim be made against the 12th. However, this does add cost and complexity, he says.

“An alternative is to have one legal entity for all stores, but maintain management accounts for each store. It is very important to keep track of how each store is performing, at the very least at a sales level, so that each store’s performance can be assessed.  Remember, a purchaser is only going to be able to accurately determine how much to pay for the part of the business you are selling, if they can identify the performance of that specific part.

Leaving a legacy, not a burden

Succession planning is future proofing – after all, anyone can be hit by a bus. Delaying planning could mean your business could be over tomorrow.

“I would always encourage our people to have conversations around who they’re training or mentoring in their business to be their successor or at least their second-in-command,” says BNZ's Harry Ferreira. “Succession planning is a big part of long-term planning, and it’s a part that is often overlooked for far shorter term goals and gains.”

Geoff Hamilton from SME Financial says a good litmus test is asking yourself if you can go on holiday without disaster striking.

“A sale-ready business is one where the owner can go away for six months and return to find the business in just as good, or better shape.”

If you can’t do that, he says, then you need to get your house in order.

“Succession plans are often reactive due to health issues, declining performance of the business, or family issues,” says McElhinney, noting that these situations are stressful and can lead to disputes.

“The business needs to have adequate books and records so that an independent valuation can be prepared, to remove any disputes about fairness.”

“Training a mentor or successor gives your business the opportunity to live past the time that you may be in charge,” says Ferreira. “As a business owner that employs people and has a number of suppliers reliant on your business you owe it to your employees and suppliers to have a good succession plan in place, to know that if something left-field happens, your business is stable enough to continue.”

New Zealand’s got talent

A big part of succession is hiring or promoting staff internally to fill bigger roles, including your own, when the time is right. Just like accountancy, logistics and inventory, there’s software available to help you do this.

“Our talent management software manages the full employee life-cycle, from hire to retire,” says Darryl Garber, head of corporate development and strategy for Elmo Talent Management Software. Launched in 2002, Elmo was cloud-based before 'the cloud' was even a thing, according to Garber, and in 2011 it launched a fully-integrated talent management platform that is affordable and accessible even for small businesses.

“Our target market are businesses with between 100 and 1000 employees,” says Garber. “But we have some SMEs with as little as 30 employees.”

Garber says the number of SMEs interested in the product is growing as the ‘war on talent’ gets more intense.

“With professional social media like LinkedIn, it’s easy to tap someone on the shoulder and make them an offer,” says Garber. He notes that for SMEs, losing an employee can have a much bigger detrimental impact than for big corporations, which makes talent management and good succession planning even more vital.

"These days it’s more recognised how important it is to hire, retain, develop and train employees and get the most out of them. It has to be more than just a job, as the value of organisations - especially small organisations - is in the employees. They need to feel challenged and have progression prospects.”

Talent management software can identify weak spots in the organisation and upcoming advancement opportunities, and using data analytics, it can find the employees that might be ready for that advancement. It can highlight areas where training is needed and timeline progression opportunities for high performers.

“An example might be a good tech employee who needs additional soft skills to become a manager,” says Garber. “The software could help identify that, and they can be enrolled in a leadership or communications training course directly from the platform.”

The ultimate goal of talent management software is to help key business players make strategic and well-informed decisions.

“Our succession module helps you understand your workforce. It identifies high performers so you can foster career potential and mitigate flight risk. It helps the HR manager or executive set out clear succession pathways and track candidates or create talent pools,” says Garber. “Previously, cost was a barrier to small businesses but now cloud-based software offers SMEs the same advantages around succession planning as large companies. If you don’t have an online solution these days, you’re not competitive.

This story originally appeared in NZ Retail magazine issue 749 April / May 2017

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