Planning for the unknown

By Wiilliam L. Shanklin

What will happen to your business after you're gone? If you haven't carefully thought this through, consider enlisting an advisory board to help you develop an effective transition strategy.

“As far as the eye can see” is an oft-heard expression. Fact is, when it comes to predicting the future, the eye cannot see very far. Preparing for the unknown is a particularly pertinent issue in family businesses because, in addition to the normal disruptions that challenge all enterprises, there are often emotionally charged intrafamily dynamics at work. These usually center on who is going to run the business, how it should operate or whether it should it be sold.

While every business has a plan for operations (even if it isn't committed to paper), what tends to get neglected in family companies is a modus operandi for management succession or for an out-and-out sale. Formulating a plan that succeeds as intended is dicey when relatives fill all or most of the top management ranks. Over the long term, many entrepreneurial families will fail to keep their businesses under family control, for lack of adequate planning.

One notorious example of a family business empire bankrupted by ineffectiveness and misdeeds was revisited in news reports in January 2005 upon J.T. Lundy's release from federal prison. William M. Wright founded the Calumet Baking Powder Company in 1888 and its namesake, Calumet Farm, in 1912. His son, Warren Wright Sr., inherited the farm and built it into Thoroughbred horse racing's most accomplished stable of the mid-20th century. Warren's widow, Lucille Wright Markey, remarried and continued the tradition of excellence until her own death in 1982. After that the farm began to be laid low when its stewardship fell into the hands of Lundy, whose principal credential for the job was being married to Lucille Markey's granddaughter. In 2000, Lundy was convicted of bank fraud, conspiracy and bribery for his conduct as president of Calumet Farm.

Planning to exit

Unfortunately, the adage “from shirtsleeves to shirtsleeves in three generations” all too accurately describes the prevalent cycle of family wealth accumulation and diminution in the U.S. Maintaining assets from generation to generation is a daunting task, especially when the capital derives from cash flow from a family-managed enterprise.

The American Family Business Survey, co-sponsored by the Raymond Institute and MassMutual Financial Group and published in 2003, provided an in-depth look at succession issues in family-owned businesses. Although the study found that “the desire to remain family-owned predominates,” it's likely that many of these families will fail to maintain ownership, for lack of adequate preparation. While 39% of the respondents said they were planning for their company to have a new CEO within five years, owing to the retirement of the sitting CEO, 55% of the CEOs aged 61 or older had not selected a replacement.

Hard-charging business owners are apt to go about their lives as though they are bulletproof. Hence, they are inclined to put off doing anything meaningful about succession planning—or, for that matter, estate planning. To illustrate, a survey of 792 very affluent American adults (people with at least $10 million in assets to invest), released in January 2005 by PNC Advisors of Pittsburgh, found that more than a third of them do not have wills, health care proxies or trusts, and have not named trustees or executors for their estates. More than half cited procrastination as the main reason for not having a will, and 12% said the reason was their reluctance to face their own death.

One business owner I know, Doug (not his real name, though his story is real), built a solid business over more than 45 years. He and his wife, Laura, had two sons. One of the sons was uninterested in joining his family's business. The other had worked for the firm on two occasions in a non-managerial capacity, only to be discharged by his father for incompetence.

Without a capable heir to take over, Doug considered an employee stock ownership plan (ESOP) but rejected the idea because of his apprehension about giving up control. What especially concerned him was that employee shareholders might challenge his personally generous expenditures for travel and entertainment, including a yacht. The arrangement tentatively agreed upon was for Doug and Laura to sell the business to the firm's general manager, Larry, who was about 42 at the time. Doug and Laura were fond of saying that “Larry is like a son to us.”

Several years went by and Doug had not made any consequential progress on conveying the business to Larry. Then, suddenly, Doug had a life-changing experience. A small plane he was riding in skidded off the runway while landing on an island. Fortunately, no one was badly injured, but for the first time a shaken Doug objectively faced up to his own mortality. He decided he'd better do something constructive about making provisions for the sale of his business.

Doug assembled a small group of advisers who worked with him to devise a method and timetable for selling the firm to Larry. But Doug soon lapsed into his old ways and terminated his advisers. Signaled thusly, Larry planned to start his own company. (Doug heard from another employee of Larry's intentions on a Sunday night and angrily dismissed Larry the next morning, before he could resign.) Initially, Doug rattled sabers about suing Larry for “stealing” his customers but backed off. Currently, Doug, now in his early 70s, is blithely running the company. His de facto exit strategy is to die on the job and let Laura and their sons dispose of the business.

By contrast, Paul, a business owner I have advised, faced up to the succession issue. Paul owned a business that operates internationally and has about 200 employees. He and his wife have 11 children from previous marriages. They were concerned about what would happen to the company upon their deaths because only two of the children were active in the business. How would the other nine siblings receive their inheritances? Paul opted for an ESOP; between 1998 and 2003 the company's employees went from owning about 30% of the firm to acquiring it all.

Sometimes when family members harbor antipathy toward one another, the best solution is for the senior generation to sell the business. The star-crossed Bingham clan (two sons were killed in separate freakish accidents) from Louisville, Ky., at one time owned a mass-media company encompassing the Courier-Journal newspaper and WHAS radio/television. Worth Bingham had purchased the newspaper in 1916 with money he inherited from his second wife, Mary Kenan Flagler Bingham. She was the richest woman in America by virtue of being the widow of Henry M. Flagler, the co-founder of Standard Oil and the original developer of St. Augustine, Palm Beach and Key West in Florida. When Mary died under suspicious circumstances eight months after her marriage to Worth Bingham, the ensuing scandal over whether she had been murdered at the behest of her husband captivated the country, although Worth was never charged. His son, Barry Bingham Sr., inherited the business and made it a regional media powerhouse. Along the way, he became prominent in the inner circles of the national Democratic Party and Harvard University. Late in his life, a feud erupted among his three surviving children over their inheritances. This contentious split motivated Barry into selling his companies rather than have the quarrel continue after his death.

‘Maybe next year'

Business owners are typically “can do” people with a sense of urgency. They generally are enthusiastic about seeking out new avenues for expanding their enterprises. Indeed, for them, devoting time to succession issues (sounds like retirement) and unpleasant scenarios like dying (sounds pessimistic) runs counter to their natural proclivities and might not be a high priority—“Maybe next year we will do it.”

Yet as the above examples show, some of an owner's deepest thinking should converge on two strategic issues:

•  “What do I want to happen to the enterprise on the occasion of my exit via retirement, incapacitation or sudden demise?”

•  “Are procedures in place that will help to ensure my intentions are carried out?”

It's a good idea to draw on others' expertise in dealing with succession issues. An advisory board of directors, which should meet at least quarterly, can be the most valuable source of independent wisdom for all kinds of strategic matters facing a business owner. It's usually easier for family enterprises to recruit competent people, especially those with a high net worth, to serve on advisory boards than it is to get them to join official boards of directors. Unlike the latter, members of advisory boards are not legally directors. For that reason, they cannot be held liable in legal proceedings against the firm, and directors' and officers' insurance is not required.

An advisory board normally consists of three or four members from outside the company, plus the firm's chief executive. To avoid conflicts of interest and redundancy, professionals who supply services to a company on a continuing basis, such as the firm's legal counsel and CPA, should not be members of an advisory (or official) board of directors. Directors whose livelihoods are not intertwined with company affairs are in the best position to offer the chief executive unprejudiced guidance.

‘The Event'

A well-conceived succession plan in a billion-dollar, privately held family business played out in 2003 and 2004 at Cleveland-based IMG, which accurately speaks of itself as “the world's largest sports and lifestyle marketing and management company” and whose clients are top athletes, celebrities and authors. Mark McCormack, the company's founder, suffered a cardiac arrest in January 2003 and lapsed into a coma until he died four months later at age 72.

McCormack had institutionalized a process that made for a smooth changeover of top management in a company with almost 3,000 employees working in 85 offices located in 33 countries. In November 2004, Forstmann, Little, & Company purchased IMG from trusts established by McCormack and thus enabled his widow and children from two marriages to cash out.

The subject of McCormack's inevitable passing away was discussed within IMG for years, although it was euphemistically referred to as “the Event.” Likewise, every family business owner must objectively think through what his or her particular “event” will mean for the business—and talk candidly about it with heirs and key executives. Frequently, problems arise after the incapacitation, retirement or death of the principal owner—not because he or she formulated a faulty plan, but rather, because there was no written strategy at all.

William L. Shanklin (wshanklin@neo.rr.com) has served on numerous advisory boards of family-owned companies. He is a visiting professor in the College of Business Administration at the University of Akron in Ohio.

Research AlertRegional survey: Family companies are unprepared for succession

A survey of 3,000 family business owners in Pennsylvania, New Jersey and Delaware found that few have developed leadership-training programs for their successors.

The survey—conducted by Kreischer Miller, an accounting and business advisory firm in Horsham, Pa., in partnership with Bryant University and the Delaware Valley Family Business Center of Sellersville, Pa.—found that 88% of the respondents ranked “leadership succession” as the most important issue facing their companies. But the study, released in October 2005, also found that:

•  87% of the companies lack a formal mentoring program for their next-generation leaders.

•  48% of respondents say they have not informed their family and employees of their management succession plans.

•  44% lack updated buy-sell agreements that determine how ownership is to be transferred.

•  43% believe their family successors are unprepared for leadership.

•  40% lack a financial plan that provides for the transition of shares and does not over-leverage the company.

•  39% lack a clear, long-range strategy for their business.

Mario Vicari, a director at Kreischer Miller, says the results indicate senior-generation family business leaders “don't want to face up to” the family issues involved in succession planning. “A lot of people view it as mostly transactional—having an estate plan or a buy-sell agreement,” he explains. “They don't view it as a long-term process. They realize that future leadership is important, but they don't realize the importance of preparing future leaders. Not a lot of them seem to be doing the hard work.”

Many respondents, Vicari concludes, are either in denial about the need to address the emotional side of transition planning—for example, by holding family meetings and establishing family policies—or don't realize the magnitude of the task. “That tells us there's a potential problem down the road,” he says.

For more information on the study, see www.kmco.com.

National survey: ‘Legacy gap' exists between Boomers, parents

A national study of more than 2,600 U.S. adults revealed that although Baby Boomers and those in their parents' generation say they are discussing legacy and inheritance, most of those conversations are not truly meaningful or productive.

The “American Legacies Study”—conducted by Harris Interactive for Allianz Life Insurance Company of North America—polled more than 1,200 Baby Boomers (ages 40 to 59) and more than 1,300 elders (ages 65 and older) about the passing of values, assets and wealth between the two generations. While 71% of elders and 68% of Boomers said they feel highly confident discussing legacy and inheritance, only 29% of Boomers and 31% of elders reported having had a comprehensive discussion covering all four core elements of legacy planning.

•  64% of Boomers and 80% of elders said they have discussed “values and life lessons.”

•  60% of Boomers and 78% of elders reported talking about “financial assets or real estate.”

•  46% of Boomers and 63% of elders indicated they had discussed “personal possessions of emotional value.”

•  37% of Boomers and 44% of elders affirmed they had conversations about “instructions and wishes to be fulfilled.”

“Among people who have already lost their parents, fulfilling last wishes and distributing personal possessions was five times as likely to have been the greatest source of conflict during a legacy transfer as the distribution of finances,” the report said. “[T]he reason this conflict is not handled earlier within families is because the greatest barriers to open discussion are personal discomfort with the topics of inheritance and death.” Another survey finding: 65% of Boomers said it's very important that they receive instruction on how their parents' wishes should be fulfilled.

For more information on the study, see www.allianzlife.com.

—Barbara Spector

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Spring 2006

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