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SUCCESSION PLANNING

No matter the size, every company needs a plan to retain top talent and prepare for leadership exits.

Succession of leadership and ownership is a crucial part of ensuring the long-term health of a company. That’s especially important now as more baby boomers are looking to make an exit and major tax changes could be on the horizon. Three Chicago-area executives shared their thoughts on this key process with Crain’s Content Studio.

What recent trends are you seeing in succession planning? What effect has the pandemic had on these transitions? Are you seeing more of them or less?

Alan Weed: We’re seeing increased interest and awareness. Companies that successfully navigated through the health aspects of the pandemic are now dealing with inflation, supply chain and labor issues and the problems are more challenging than ever. Many baby boomer owners who delayed an exit during the pre-pandemic economic boom are spending their late-stage career years in a different way than they envisioned. We have seen this cause more business owners to focus on finding a solution that allows them to retire or exit from their business and get some help navigating this challenging operating environment.

Melissa Mabley: The pandemic and subsequent market conditions, coupled with an aging generation of business owners, have led to several trends in succession planning. The Great Resignation brought into sharp focus the fact that succession planning can’t center only on c-suite or senior-level executives.

An organization is vulnerable any time a key producer or stakeholder departs, and as a result emergency

to entry, reducing the pool of potential buyers.

Michael Gray: Potential tax law changes are driving family-owned and privately held companies to review and update their succession plans.

Additionally, the influx of private equity firms entering the market has changed the way many companies view their succession planning.

The potential for a private equity backed exit transition has become an increasingly attractive option. The pandemic has changed the dynamic for many businesses and increased their risk profile.

How can companies avoid contentious exits of leadership and key staff during transition periods?

Weed: One effective approach is to practice transparency and communicate the succession plan to key members of the company. In doing this, you are showing your key employees that not only do you care enough about them to keep them informed, but that they have an opportunity to be part of the company’s future growth. This is very important because a common reason that employees leave a company is that they don’t see potential for the future. Additionally, there are other compensation-based strategies such as

“LOOKING AHEAD AND EVALUATING THE FUTURE NEEDS OF THE BUSINESS IS THE CORNERSTONE FOR DEVELOPING TALENT AND IDENTIFYING FUTURE LEADERS.” — MICHAEL GRAY, NEAL GERBER EISENBERG

or contingency planning has become an increasing trend. Baby boomers approaching retirement age own 51% of private companies, and have cited market conditions and economic outlook along with their health as primary reasons for considering transitions. The rise in interest rates and increasing cost of capital could negatively impact the sale price of businesses.

Additionally, as interest rates rise, securing financing can be a barrier

MICHAEL GRAY

Partner Neal Gerber Eisenberg mgray@nge.com 312-269-8086

concerns about nepotism that can be difficult to overcome; a primary goal of a family-owned business is often

MELISSA MABLEY

Wealth Advisor Bartlett Wealth Management mmabley@bartlett1898.com 312-588-7787

to provide employment opportunities for future generations within the family. Demonstrations of the future

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retention bonuses that can be useful options to help make sure a team stays in place after a business has been sold.

Mabley: Just like in any relationship, communication is key. Absent communication, people may draw inaccurate or incomplete conclusions.

In a family-owned business with non-family employees or leadership, communication is especially important during times of transition.

Non-family employees often have

Learn more about our practical approach to helping you, your family and your business at nge.com/Client-Services

ALAN WEED

Partner Arbor Investments weed@arborpic.com 312-981-3776

leadership team’s aptitude and commitment to non-family employees over time will also inspire confidence.

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SUCCESSION PLANNING What tactics are most successful for cultivating and maintaining talent and future leaders?

Gray: Looking ahead and evaluating the future needs of the business is the cornerstone for developing talent and identifying future leaders. The business needs a roadmap to guide it regarding what sort of talent is needed and how to foster and maintain it.

Focus not only on the strengths of the current team members but also their weaknesses. This analysis provides company leadership with a chance to address weaknesses in advance, whether it be through training to address skill deficits or the identification and hiring of outside talent to fill the specific needs for the future of the business.

Structuring the company’s board and its meetings properly is important. Be sure the board includes third parties from outside the business. The board needs to plan out an annual roadmap of key items to be discussed at each meeting in addition to the day-to-day activities. Meetings should include senior management and the next generation of leaders and give them the opportunity to present to the board, grow their presentation skills and feel part of the enterprise’s future.

Weed: We attract and maintain talent at our portfolio companies by creating a strong culture where our employees are empowered and

see opportunities for advancement.

One way we do this is by formulating a joint strategic plan alongside our management immediately post-acquisition to align on a growth strategy for a company.

We collectively identify areas of opportunity or needed investment and execute on them together. This complementary approach provides key employees the autonomy to drive the direction of the company, but with a partner to support them with capital and expertise. Additionally, we also focus on compensation design to make sure that our packages are leading-edge and frequently utilize stock-based compensation plans to let key employees participate in the meaningful value that they create.

How is succession planning different for family-owned vs. non-family-owned companies?

Gray: In a non-family-owned business, more diverse and independent voices are likely to have input in the decision-making process.

Leadership needs to start early to educate and communicate while building consensus for succession plans. Depending on the structure of the business and the make-up of the company’s board, the viewpoints of the operators of the business versus people outside the business need to be considered. The time horizons for succession planning are typically quite different for family versus non-family

owned businesses. Family-owned businesses tend to have a longer time horizon for transferring control from family member to family member, usually accounting for transfers across future generations. Non-family owned businesses are usually subject to shorter timeframes as leadership considers business in economic terms and exits for investors. The long-term goals of family businesses usually focus on control and a disciplined transition to the next generation while non-family businesses focus on the liquidity and profit generated by a sale or transition of the business.

ABOUT THE PANELISTS 30% most likely had a realistic and deliberate succession plan that aligned all the family constituencies to allow for owners to decide what succession planning solution was truly the best fit for their company.

Mabley: Family-owned businesses will often look to members of the next generation when succession planning. In this scenario, there can be complicated tax and estate planning considerations related to gifting shares of the business and/or the eventual sale of the founder’s interest over time. In a

plan (ESOP), we try to determine the minimum target that will achieve their financial goals. If they are instead considering a family ownership transfer, we work through options for selling or gifting shares of the business over time. In the case of an ESOP, we need to know if employees have the financial means to purchase the shares, while in a family ownership transfer we determine which portion should be gifted and which should be sold. When selling a business, you generally need to account for a significant taxable gain.

The vast majority of tax planning or

“THE GREAT RESIGNATION BROUGHT INTO SHARP FOCUS THE FACT THAT SUCCESSION PLANNING CAN’T CENTER ONLY ON C-SUITE OR SENIOR-LEVEL EXECUTIVES. AN ORGANIZATION IS VULNERABLE ANY TIME A KEY PRODUCER OR STAKEHOLDER DEPARTS.” — MELISSA MABLEY, BARTLETT WEALTH MANAGEMENT

Weed: Both family owned and nonfamily owned companies are generally both seeking to create a succession planning solution that preserves the long-term success and value of the business. However, succession planning in a family business has a lot more emotional elements with family issues added to the mix. I think most people have seen the statistic that only 30% of family-owned companies make it to the second generation. That

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non-family-owned company, the challenge comes with buying out retiring partners. There are two main options: a buy-sell agreement or a management buyout. A buysell agreement is a document that determines how a partner will be bought out in the event of his/ her disability, death, or retirement by the remaining partners, while a management buyout sells the business to current employees or managers. It’s helpful if the partners are willing to finance the sale to their younger employees over time, allowing enough working capital to remain in the business to continue growth.

What financial considerations are most important in succession planning?

Weed: If a sale of a company is desired, an owner should assess what a buyer will use to generate a valuation — such as how much annual cash flow the business will produce for the new owner. Additionally, the owner will need to determine how much of the business to sell.

An approach that seems to appeal to many business owners is selling part of the business and working alongside a buyer to formulate a growth and succession plan for the next five to 10 years. This approach gives an owner liquidity now, but also allows them to stay involved and can result in additional proceeds commonly known as a “second bite of the apple” if the company is sold again. In the case of a pure leadership transition — the financial considerations usually relate to compensation design to properly retain and motivate new or existing team members.

Mabley: When we work with business owners, we start by running a financial plan that includes different business valuation scenarios. If they are considering a third-party sale or an employee stock ownership

tax savings techniques are charitable, and all of that planning must be done prior to signing a letter of intent.

Gray: In family-owned businesses, it is important to think about the family members who are going to be actively involved in the business versus those family members who are going to be passively involved.

How do you motivate those family members who are ready to take on the responsibility of running the business? Compensation of the active family members versus compensation of the non-active members must be clearly addressed.

What role can private equity play in succession planning?

Mabley: Selling to a private equity firm can be a great strategy in the event that a founder’s family isn’t interested in or capable of running the business. Generally private equity will buy a majority or “controlling” stake in a company and require that the owner/operator stay on to help run and grow the business. This allows the founder to partially monetize their business while still participating in the day-to-day operations, with potential for a lucrative future valuation at the eventual sale of the company. This can be very beneficial to an owner from a financial perspective, but it’s critical that they have the interest and the drive to help scale the business.

Weed: Private equity firms frequently look for companies that they can partner with existing owners and teams and continue to grow.

This can be compelling for an owner because it provides liquidity from an exit but allows an owner to maintain a level of ownership and involvement that are agreed upon with the private equity partner. A private equity firm will even use their contacts to help an owner find a successor if there isn’t one inside the company. A private equity transaction can serve as an alternative

to selling a company to a competitor within the same industry, which can be a less desirable option for an owner.

It’s important to find a firm that has the same values as the owner.

Gray: Private equity investment provides liquidity for family-owned businesses while also allowing family members who want to stay involved and participate in the future growth of the business an option through rollover equity. Aligning with the right private equity firm can expose the company to growth opportunities for the business and access to experienced management talent.

Private equity can also offer transition opportunities to family members but retain economic upside for the family by bringing in new management.

What questions should a business owner ask a potential investor if they are contemplating outside capital?

Weed: Bringing in outside capital is a major decision for a business owner and requires significant due diligence. The most desirable outside investors tend to have experience and a strong track record of results. For most companies, the goal should be to find outside investors that are valueadded and understand the nuances of a company and segment. Some questions to ask about these qualities include: How is this investor going to create value for my company or are they just a capital source? Do they have relevant investment experience and understand my company and industry? What is their investment track record and investment returns?

It is also important to gauge the fit of a working relationship and to talk to other business owners who have previously partnered with

members and C-suite executives is critical to understanding how they are going to treat you as a partner.

Diligence is a two-way street.

How do potential tax rate or interest rate changes impact succession or liquidity options for private companies?

Weed: When tax rates are anticipated to rise, there tends to be a heightened interest in exiting a business though an outright sale.

This occurred during the second half of 2021, in advance of potential tax changes on both ordinary income and capital gains. A record number of business owners exited their companies during this period to avoid what could have been a very large tax hit. Interest rate changes tend to have less of an impact, but rising rates do generally slightly slow down merger and acquisition activity. Another consideration for many business owners is where they are going to invest the proceeds from the sale of their company. Record low interest rates mean fewer attractive yield generating investment alternatives and can cause some sellers to delay exit. In this situation, rising interest rates can help by providing a seller with more compelling yield options for sale proceeds.

Mabley: The current tax proposals around capital gains could significantly impact the proceeds a business owner nets from the sale of their business. One proposal would increase the capital gains rate on sales above $1 million from 23.8% to 43.4% federal. For example, a business owner who sells for $25 million could see their tax bill go up by $4.9 million if this is passed. There is discussion around eliminating the

“FOR MOST COMPANIES, THE GOAL SHOULD BE TO FIND OUTSIDE INVESTORS THAT ARE VALUE-ADDED AND UNDERSTAND THE NUANCES OF A COMPANY AND SEGMENT.” — ALAN WEED, ARBOR INVESTMENTS that investor. Finally, and maybe most importantly, an owner should make sure they personally would enjoy interacting with the potential investor on an ongoing basis.

Gray: Conducting thorough due diligence on the potential investor starts with discussing their current and past investments. What motivated their investments? In the case of past investments, what motivated their exit? What are the baseline metrics they use to evaluate the performance of their investments? Another important point of diligence is talking to family members and C-suite executives of the investor’s current and past companies. Understanding how the investor approaches rollover family

step up in cost basis at the death of an owner, which would have a lot of implications from an estate tax perspective. The current estate tax exemption is $11.8 million, which is set to sunset at the end of 2025.

The tax proposed change would move it to an inflation-adjusted $3.5 million (about $5 million). In anticipation of this, some business owners are accelerating some family gifts to take advantage of the current exemptions. The rise in interest rates and increasing cost of capital could negatively impact the sale price of businesses and create a barrier to entry for potential buyers.

Gray: It’s important to evaluate the business and its value in terms of now versus later. At this time,

MICHAEL GRAY, a member of Neal Gerber Eisenberg’s Executive Committee, leads its Private Equity, Venture Capital & Growth Companies practice and Fund Formation & Investment Management practice. Gray concentrates on transactional and corporate governance matters, including mergers, acquisitions, private equity and venture capital investments. He represents private equity sponsors, venture capitalists, hedge funds, private equity and venture-backed companies, investors in private ventures, executive teams and family offices in their investments. He has extensive experience with fund counseling, including representing general and limited partnerships in fund formation.

MELISSA MABLEY is an experienced financial planner and wealth advisor with Bartlett Wealth Management.

She is a Certified Financial Planner (CFP®) and Chartered Divorce Financial Analyst (CDFA®) and holds an MBA. Her diverse skills make her especially well-suited to serve Bartlett clients who are experiencing major life events and transitions.

Mabley has served in various planning and leadership capacities with companies such as Kovitz Investment Group, RMB Capital Management, US Trust and LaSalle Bank Corporation. Mabley is on the board of Tuesday’s Child, an organization that helps families address behavioral issues of children through individualized training.

ALAN WEED is a partner with Arbor Investments, a specialized private equity firm focused on acquiring companies in the food, beverage and related industries.

He joined the firm in 2003 and has almost 20 years of experience investing in and working with privately held businesses. Weed serves on the board of directors of select Arbor portfolio companies including Rubix Foods, Dr. G’s Creations, Fontaine Santé, Concord Foods and DPI Specialty Foods. He holds a master’s degree in business administration from the University of Chicago Booth School of Business.

many private equity firms, flush with capital, are paying premiums for businesses. Attractive multiples are leading to an increase in the number

of exits from private companies.

Will the debt markets to fund the private equity-led deals at these high multiples dry up? Will interest rate

hikes drive down the high multiples?

The next few months should give an indication of what lies ahead for private companies in 2023.

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