What happens next when the boss dies?

Succession planning is vital for business, writes George Frier

If senior directors have not shared the burden of management, their loss could significantly destabilise the business. Picture: Ian rutherford

RISK is an integral part of business life – and assessing and minimising risk is part of every director’s workload. How much attention is paid to internal business risk – the risk attached to key personnel and the structure in which they operate?

One of the biggest risks is where an owner manager will not face up to his/her own mortality. The longer issues of management and personal succession persist, the longer the risk to the business and to the wealth of the families that rely on it.

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In a typical private business, with, say, two second-generation siblings as shareholder directors, with different family interests and aspirations, typically there will be no clear idea of succession or exit planning. The business generates healthy profits, but the directors keep going, enjoying the benefits of healthy dividends, on the basis that they are not yet ready to retire.

There are many risks here including: The risk of dying “in harness” or suffering a critical illness.

If senior directors have not shared the burden of management, their loss could significantly destabilise the business. The risk that the business then loses key customers or staff.

Realistically, competitors will capitalise on any instability.  Are there adequate restrictive covenants on key staff preventing them leaving and transferring the goodwill to a competitor?

Lenders and suppliers may be concerned to see the loss of key management. If coupled with loss of customers there will be increased pressure or even a requirement to address repayment of bank debt.

The variations on the risks are as diverse as private businesses themselves. If the two siblings are years apart, then there may be a dislocation between their retirement plans. What appetite does the younger have to buy out the older, and will the older feel resentment if the younger is not prepared to facilitate his/her exit?

There are many ways to address this disconnection and minimise the risk of tension. The shares held by the older retiring party could be repurchased and the proceeds of sale re-lent to the business to minimise cash flow risk. If nothing is done, the ultimate risk is of death of the older sibling with ownership of his/her shares still unresolved resulting in possible transmission to a spouse or children who are disconnected with the business and may then be resentful.

For many family-run businesses, taking the time to review these structural issues often falls into the “too difficult” box. The biggest risk is of ignoring them, so: review key areas of business risk including whether the business would be exposed to sudden change or loss of any key person; discuss management succession well before you need to; and are bloodline candidates necessarily the best, or would a transfusion of external skills assist?

Determine what the guiding principles of shareholding should be – eg, bloodline only, working, or what? Consider the pros and cons carefully, particularly if looking at external candidates – how will they be best motivated to make the business prosper?

Consider where you and the family (families) want the business to be in 20 years’ time. What are your and their ambitions for it? There will be a significant risk to the business and family cohesion if there is no discussion about this is left too late.

Review the current value of the business – you might surprise yourself! Investigate cross option policies particularly if different workers are key shareholders. On their death the proceeds of such policies, properly written for sufficient cover, can relieve significant tension by allowing a purchase to take place which can be in the interests both of the deceased’s family and the continuing business.

Discuss your thoughts with your advisers including how to harmonise interaction between insurable matters, articles of association and estate planning.

Formulate a basis for a structured discussion on the future, which might need to be facilitated, and which should take place on a planned and not a reactive basis (Boxing Day after red wine is rarely recommended).

Pai rico, filho nobre, noto pobre: in Brazil, “Rich father, noble son, poor grandson”. Make it your legacy that you guarded against that risk.

George Frier is a corporate partner and member of Shepherd & Wedderburn’s Family Business & Wealth Protection Group www.shepwedd.co.uk/sectors/family-business-wealth