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Succession planning: The key to your businesses' ongoing success

Succession planning: Important to future success

Some years ago I did business valuation work in the newly independent country of Slovenia. At one successful enterprise I asked the CEO about his firm’s succession plan. After I told him what this was, he said his company did not need one. He was going to be there another 10 to 15 years.

He was 55 years old and excelled at wining and dining prospective clients. The CEO was at least 50 pounds overweight and smoked heavily. I considered this to be a perfect example of “Key Man Risk” (now key person risk). The firm’s value was highly dependent on a man whose health was questionable. No one was prepared to take his place.

Therefore, I added 5 percentage points to the firm’s cost of capital when calculating its value, reducing it significantly.

Six months later the CEO suffered a massive heart attack on the tennis court and died on the way to the hospital. The firm suffered as I had anticipated.

While I take no satisfaction from this tragedy, it provides a vital lesson for business owners: The value of your investment may be at risk if your company depends on one person and you do not have a succession plan in place should this story repeat itself in your case.

Recently, a local business owner almost lost her business when she was infected with the West Nile virus. Because she did not have someone prepared to take over her leadership position while she was ill, her real estate company shrank from one of the region’s largest and most successful to a very small one.

This business owner lost the majority of her most productive agents, and she now operates out of her home with a limited staff complement. The lack of a succession plan also negatively affected a small business whose owner was preparing to retire. The success of the company depended on his technical expertise in supplying marine services to local owners of docks and marinas.

His operation was very profitable due to his unique skills, but without him his firm would be worth very little to another owner. I advised him to immediately hire assistants and transfer his valuable knowledge and skills to them as quickly as possible. When I explained these situations to a group of downtown neighborhood association members, one of them became unusually quiet. When asked if something was wrong, this owner of a major tourist operation in the city said he had to talk with me soon about succession plans.

In a final situation, family members who owned a company in Wisconsin had become dependent upon a general manager their mother had hired to run the firm after their founder-father died. Over the years, this manager kept all crucial business decisions to himself, including negotiation information with key customers.

Since the owners had no one else to rely upon, they were panicked by the thought of his leaving the firm. He had made himself the key man, and they let him take total compensation more than double what the size and profitability of their company would demand on the market.

Succession planning is not complicated. It generally involves preparing one or more people to assume each vital position in an organization, including that of president or CEO. To accomplish this, the firm must view humans as their most valuable assets and then invest in these assets. This entails serious education, training and development. More importantly, people selected for these assignments should be allowed to participate in the discussions that lead to decisions their future position would have to address.

We often joke about the empty role of the vice president of the U.S., but thoughtful presidents have involved their second in command in all strategic discussions. Only then could the vice president be prepared to lead the country should the president suddenly be unable to serve due to illness or death. Succession planning can be considered the epitome of management development within the firm. Doing so usually develops greater loyalty of key people to the organization. Their importance to the firm is recognized. Owners will not overlook them and replace a key person with an outsider.

Successful succession planning may also develop a potential buyer for a small firm when the owner prepares to retire. If key employees are prepared to run the company, they may also be the best buyers of the firm. This purchase can be structured as an employee stock ownership plan (ESOP), which has significant tax advantages for the buyer and seller.

Too many small business owners overlook this possibility when they fail to attract an outside buyer.

Succession planning is equally important for the nonprofit sector. No one in these organizations should ever be considered irreplaceable. Each nonprofit should be able to function if its executive director or key manager leaves for any reason.

If a succession plan is not in place, boards of directors can be woefully unprepared to address key operational issues and can put the organization at risk for failure. Businesses and nonprofits protect their organizations when succession plans are put in writing and accessible in times of transition whether planned for or in the case of unplanned for circumstances.

Kenneth Zapp, Ph.D., is a professor emeritus at Metropolitan State University, an adjunct professor at Savannah State University and a mentor at SCORE Savannah. He may be reached at KennethZapp@metrostate.edu.

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