Regression—or Succession?

There’s a very good etymological reason why succession planning starts with the letters s-u-c-c-e-s-s. Delays in planning for it, experts say, could create the biggest threat your business will ever face.

If American small business had just one color, it would probably be . . . gray.

Depending on the source, as many as one small business in eight—perhaps one in six, or even more—is owned today by someone who has moved so far down life’s road he can’t even see his 65th birthday in the rear-view mirror.

And according to the Small Business Administration, the owners of companies with fewer than 500 employees are, like the rest of the nation itself, older today than they were as a group in 2007. In fact, the fastest-growing segment of small businesses ownership is being driven by people ages 50 to 88—that’s right, eighty-eight: the SBA is tracking at least one high-end octogenarian still at work out there.

Those figures portend a great deal of change over the coming decade or two, as more entrepreneurs from the Baby Boom generation decide it’s time to harvest the fruits from a lifetime of labor:

  • As a nation, we could see an unprecedented number of businesses go on the market for sale—or, worst-case scenario, huge numbers of businesses shuttered because no buyer or heir has emerged to continue the corporate legacy.
  • Services for tax planning, succession and business brokerage are likely to be in higher demand, and with greater demand, you can expect increased costs.
  • And the continuing trend of fewer operating businesses each year in the U.S. could continue, meaning that competing firms of those Boomer businesses will see opportunities to capture market share.

For many owners of those businesses, the time is now to make preparations for what happens when they’re ready to pull the trigger on an exit strategy. For others, the time is now to start thinking about an exit strategy, period: By some counts, 30 percent of all family-owned businesses have yet to confront that existential question. Worse, some 37 percent of owners who are already 65 have yet to take it up.

Failure to do so, business brokers say, could prove financially disastrous, especially in the event of unexpected death or disability. It could jeopardize an owner’s ability to fully fund the retirement he dreams of. It could rob surviving family members and prospective heirs of a livelihood. It could to both by generating a tax bill that could dramatically reduce the proceeds of a sale.“What happens is, they’re getting older and they don’t think about it,” said Wayne Moorhead, of Moorhead Business Brokerage in Leawood. “Today, they have an operating business with a market price, but the day they die, it becomes an asset sale if the business is terminated, and that’s what you get out of it. Unless you have a plan for succession as an ongoing business, you’ll suffer a serious financial hit.”

How serious?

Moorhead estimated that, on average, at least half the value of a business is lost with an asset sale, and in some cases, depending on the business sector and other variables, as much as 75 percent. As important as capturing that full value is, there are other factors at work, professionals say. A family-owned business cast into organizational chaos can have long-lasting and deeply divisive consequences for an owner’s survivors, something that few wish to leave as their business legacy.

Perhaps the biggest benefit that comes from a finely tuned succession plan, professionals say, is what happens with the very first step. In most cases, any initial inquiry with a broker or lawyer about how to set up a plan will lead back to critical questions: Is your business at its peak value right now? And if not, what do you need to do in the time you have left to get it there?

“Unfortunately, they may not have planned enough to have adequate capital to live until they die, and many people don’t realize how long they might live,” Moorhead said. “We’d all like to get enough money to carry us ad infinitum, but in some cases, they’ve got to go back and work a few more years, because they can’t live on what the market price is. Or they’ve got to pay taxes on a sale, especially if the company is a C corporation.”

So with nearly three owners in five already recognizing that succession issues pose the greatest long-term threat to their business, what’s holding them back? According to various specialists in brokerage and succession law:

  • Generational conflicts often emerge, grounded in visions about what the business model should be, what values should guide the leadership or what the growth strategies should be.
  • Children have seen the toll that small business ownership has taken on their parents, and have decided that they don’t want a lifestyle tied to those demands.
  • Some owners—Moorhead calls them “the fighter-pilot types who think they’re never going to die”—simply don’t envision doing anything else in life but working. (For the record, Moorhead himself was a fighter-pilot in Vietnam. A full 34 years into his brokerage career, he has no plans of his own to call it quits.)

Knowing the Stakeholders

These, of course, are questions, that don’t confront the Fortune 500 CEO, or even mid-size companies. Boards of directors and senior management of those companies are charged with crafting strategies for long-term organizational success. So succession planning is often layered throughout those companies, down to department-head level.

But just because a business is small doesn’t mean it lacks equivalent stakeholders. In many cases, those at the larger end of the 500-employee scale may indeed have their own boards of directors. For companies that are truly family concerns, there may be a family council, especially if younger members have been granted shares of the enterprise or bought their way in. Others, such as friends, peers and trusted advisers, may have acquired stakes through the years. All need to have a voice in the succession planning process.

Changing leaders is unquestionably a stressful time, workplace authorities acknowledge, but the very process of crafting a step-by-step plan, and one that includes success metrics to validate that progress, can help companies that have hit a plateau find new direction, or energize a talented but rudderless staff. A comprehensive plan would likely address the company’s vision, values and governance, but also operational dynamics, such as definition of responsibilities. The last part is critical, because many family businesses—where each member may wear multiple hats—often fail to address questions of whether those responsibilities match each individual’s competencies.

The Business Gene Pool

If anything, the continued push of Baby Boomers past the age of 65, at roughly 10,000 a day, suggests that more older-entrepreneur enterprises—often dubbed Second Chapters—are yet to come.

And that, says Dane Stangler, vice president of research and policy for the Kauffman Foundation, would be a good thing, even if most of those second acts tend toward commercialization of a hobby or interest, rather than creation of jobs that yield truly disruptive innovation.

“We haven’t dug deeply into the qualitative aspect” of Boomer business formation, Stangler said, “but based on some research and general knowledge, I would offer the view that any type of entrepreneurship is important. Business development at any level, irrespective of someone’s age, that economic activity is going to add jobs, and in some cases, innovation.”

What the nation is experiencing with older Boomers starting business, those who study them say, is the application of a lifetime’s worth of business skills and application of critical-thinking processes that give those owners better chances of long-term success.

“Presumably, it’s a steadier presence, based on their experiences,” Stangler said. “In a lot of cases, because they are drawing on that experience, it could be that the survival rates are higher, which is a plus for economic development. And they offer good role models for the rest of the entrepreneurial fabric. We’ve seen a huge explosion of interest in entrepreneurship, especially among younger people, so the more models, the better for the overall community.”

Moorhead said the non-financial aspects of life experience are clearly at work when it comes to the most critical factor in business start-up success: capital.

“The biggest challenge is always more capital, and that runs to the advantage of the older entrepreneur,” said John Addessi, a consultant with the Small Business Development Center at Johnson County Community College. “A lot of kids coming out of college have no collateral, and if they’re looking for a bank loan, the bank is going to want collateral; they won’t make a loan on just any business idea, in this environment, no matter how juicy it sounds. You have to have some wealth that can be converted.”

So home-equity loans, retirement-fund rollovers and networks of others with the means to invest in a business are all likely to be in the toolkit for older owners, Addessi said. Even with the support of the SBA, he said, having Uncle Sam as co-signer doesn’t change the fact that the banks ultimately get to decide on whether the loan will be issued.

“And I don’t anticipate that things are going to get a lot looser” in terms of lending practices, Addessi said. “What happened 10 years ago was an anomaly, when things were much looser. Remember ‘It’s a Wonderful Life,’ where the banker tells George Bailey he has no collateral, and that he’s worth more dead than alive? That’s the way banking was for a long time, and it’s back for a while.”