A Partnership Survival Plan

Planning for retirement or succession can bring out the worst in even the best partners. Here's what they can do to remain on good terms and get through the rough spots in negotiations.

By Randy Bliss

”I should have bought stock in the company that makes this stuff,” Ron said as he tossed the drained bottle of antacid in the waste basket. The anxiety and stress of the partner relationship with his brother, Mike, not only made life around the shop unbearable but was having an impact on Ron’s health.

Ron and Mike owned and operated a small engine sales and repair business that they inherited from their father 24 years ago. They divided up the responsibilities the way many partners do, with one brother in charge of sales and finance and the other managing operations. Mike and Ron had generally worked well together in the past, but ever since Ron’s two sons entered the business four years ago, small disagreements were now turning into major blowups. In addition, with both partners now in their late 50s, the need to plan for retirement had posed new set of potentially explosive issues.

Mike wanted to retire in a couple of years, but was sure that Ron’s two sons, Terry and Jim, could never run the business. His two nephews weren’t willing to put in the long hours necessary to maintain the business, he felt, and one of them had been given a salary by his father that was far too high.

Terry and Jim were well aware of their uncle’s concerns and believed them totally unjustified. “He’s always been resentful of us being in the business, especially when his own son decided on a different career,” Jim commented.

In my experience as a counselor to family businesses I have found that by far the most difficult succession cases are those in which partners are approaching retirement and members of their families are involved in the business. Almost without exception, partners who may have worked together well over the years, or at least tolerated each other, find themselves on different sides of the table when one partner is ready to retire.

The retiring partner develops different goals and a new attitude toward risk. He or she wants less involvement in the business, less worry. He wants to be sure of a steady income in retirement, so he is likely to oppose any investment that poses risks or jeopardizes cash flow. Because leaving the business may involve a stock buyout, he favors a valuation of the business that is on the high end. If he has personally signed for any of the company’s debt, he will want to be released from this obligation and have the remaining partner assume all liability.

The partner who remains in the business, of course, is likely to have different goals. He or she will want to set a low value for the buyout and prevent excessive drainage of capital from the firm.

As the time for transition gets closer, the partners try to work on these issues themselves, usually with the assistance of an attorney. Because the issues are so sensitive, however, they often make little progress. By the time I am called on to help, most partners have been working on their transition plan for five to seven years and getting nowhere. Sure, the attorneys have done their job: There is a neat stack of legal documents—all unsigned and gathering dust. That is because the real obstacles are not legal issues but “people issues.”

SEEDS OF RESENTMENT

The seeds of the problem have been sown throughout the years of the partnership. As in many family businesses, the partners have often built little if any financial security for themselves apart from the business. Some partners think that the business real estate will provide them with a steady retirement income. Unfortunately, they forget that the rent payments are secure as long as the tenant—in this case, the business—is solvent. If the business in trouble and unable to pay, the retiree is faced with the necessity of having to evict a brother or sister or nephew or niece.

Negotiations over retirement highlight some of the problems of decision-making in the typical partnership. Partners tend to communicate well and reach a consensus on issues that are fairly straightforward and uncomplicated. They have a much more difficult time when the issues are personal or involve a serious difference of opinion over a business decision. In such cases, the decision usually occurs by default—that is, there is no decision. Or one partner will exercise a “veto” over a move that he or she opposes. Often one partner will keep important information to himself, or will make a decision unilaterally, letting the other partner know only afterward and risking an argument.

Over the years one partner may become dissatisfied with some aspects of the other partner’s work habits or skills. Often what happens in this situation is that the concerned partner starts to assume some of the duties that he feels the other has neglected. The first partner takes on more work and may put in longer hours than the underperforming partner, while resenting the fact that the other is drawing equal pay. The resentment builds over time, and usually family firms do not have a board or other forum in which to express these feelings or review performance goals and work responsibilities. At succession time, when the “performing” partner insists that his greater commitment and effort should be rewarded in the buyout terms, the explosion can be heard in the next county.

DISPUTES OVER SUCCESSORS

The habit of non-communication on personal issues can undermine succession planning, a process which depends so much on open communication and trust. If there are communication and trust problems between the original partners, members of the next generation may “inherit” the decision-making style of their elders, continuing the pattern of not dealing effectively with serious issues.

Some partners do resolve personal issues before it is too late to negotiate a satisfactory succession plan. Two partners in a large wholesale distributor, for example, overcame a major obstacle to the buyout of a third who was retiring. The retiring partner was concerned about the abrasive personality of one of the other partner’s sons who was employed in the business. Word had gotten back to this partner that other employees felt the son’s behavior was damaging relations with key customers. When the issue was openly discussed for the first time, with the aid of an outside facilitator, it became apparent that the father of the abrasive young man was unaware of the extent of the problem. With the father’s support, the group took up the problem with the son and developed a plan to help him improve his interpersonal skills.

Another major problem occurs in companies that lack consistent standards for employment and evaluation of family members. Janice and Bill, sibling co-owners of a large plumbing and heating supply house in the Southeast, provide an example of how little attention partners sometimes give to such standards. Janice managed outside sales and the counter, and Bill, purchasing and the warehouse. The business had grown significantly in 20 years, and a number of nieces and nephews had joined the firm. Although Janice and Bill communicate well on most business issues, both hired members of their respective families pretty much on own, without consulting the other.

Bill promoted one son to warehouse manager without telling Janice. He also hired another son and the first Janice knew of it was the day the young man showed up for work at the office. This second son was having personal problems that affected his performance and was undermining employee morale. Janice pleaded with Bill to do something about the problem, but he refused.

“I fired my daughter when she couldn’t cut it,” Janice admonished, “and you ought to do the same.”

“What about your son in the Atlanta territory?” was Bill’s rejoinder. “Sales have never been worse there. What are you going to do about that?”

Because the family issues are now so severe, succession will not happen and the company will have to be sold.

Most partners when they begin their business are very good at dividing up the responsibilities and defining the boundaries of their domains. Each partner will usually be in charge of a major function and work independently for the benefit of the company. The coming of younger family members to the business greatly complicates the division of work, however. Unless the partners have clear and specific work roles for themselves and other family members, transition planning can bring out the worst in even the best people.

BUILDING A FOUNDATION

For those just starting out in partnerships or still years away from a transition, the best way to head off trouble later on is to anticipate these problems and put in place mechanisms for confronting them. The following elements can strengthen the partnership for the long run:

Have real board meetings. Board meetings provide a forum in which partners can make sure that they agree on important matters such as the mission and strategic direction of the company. But the meetings can also permit periodic discussion of each other’s roles, compensation, and performance. The board need not have outsiders on it or conduct formal performance reviews in order to be helpful. The important thing is to have a regular place to talk about what each partner is doing and the progress he or she is making.

The partners can set some performance goals for themselves at the beginning of the year and review them at year’s end. The meetings are also excellent occasions for partners to share retirement goals and discuss potential involvement of other family members. Minutes should be kept in order to ensure further reflection and follow-through on the discussions.

Have joint meetings of the partners’ families. A family council is one way to keep inactive shareholders and non-participating family members informed about developments in the business. The goal is not to involve family in day-to-day operations but to help the members understand their roles and keep family and business issues separate. Even when partners are not related, their families should meet together occasionally, to receive an update on the status of the business and review plans for the future. This can be a tremendously effective way to keep communication open between the families and promote unity.

Write an adequate buy-sell agreement—and keep it up to date. Decide now on the terms for a possible buyout, and develop a plan for financing it. The plan should go well beyond the typical buy-sell agreement, answering—in writing— questions such: How will the value of the business be determined when the buyout time comes? What will the potential components of the buyout be? If next-generation family members work in the company, how will the stock buyout affect their ownership, control, and job security?

Many older partners never get around to revising their original buy-sell agreements, even after they have brought children into the business. The ownership rights of grownup children who have worked in the business for many years may be placed in jeopardy unless clarified in a new agreement.

Diversify sources of retirement income. Sure, you have to reinvest some of the profits of the business in future growth. But partners should also use some earnings to build a portfolio of assets for retirement. Instead of buying a new sailboat, for example, they might invest a qualified pension plan such as a Keogh or a 401(k), where funds can accumulate tax-free over the years.

Develop a Family Participation Plan. In partnerships owned by different families, rules for consistent treatment of family employees are doubly important. The plan should deal with requirements for entry into the business; hiring procedures; performance reviews and compensation; disciplinary procedures; minimum work hours; distribution of ownership; and selection of leaders.

Break down walls and promote teamwork. Prevent the company from becoming divided into family enclaves. Family members should not be hired by their parent alone and restricted to the parent’s division or department. In many families, an aunt or uncle can be a more disinterested mentor than the parent. A more important point when planning the careers of the next generation is that they may or may not have the same aptitudes or interests as their parents. Just because on partner always handled sales, doesn’t mean that’s the best “fit” for his offspring.

Provide real opportunities for members of the next generation to work together and develop teamwork. Have them participate in strategic planning or other specific projects in which they can learn more about one another’s ideas about the business and management styles.

Set up an advisory board. An informal board of advisors can be very helpful in planning succession for partnerships. It can, for example, provide guidance on developing criteria for evaluating and selecting future leaders. The board should not be made up of the company’s regular advisors, who may be viewed as more loyal to one or another partner. I have found that other business owners provide the kind of judgment needed.

STEPS TO AN AGREEMENT

For partners who are nearing a transition in leadership, it may be too late to build organizational structures to prepare for it. Instead, the partners must take more immediate steps, setting out specific tasks to be accomplished in agreed-upon stages:

Step One: Hire a quarterback. As mentioned earlier, many partners struggle with these issues for years and end up deadlocked. To get the transition process moving, you need a quarterback to call the signals and make sure decisions follow a timetable.

Be sure that any facilitator/negotiator you hire has experience working with partnership transition issues. Again, one of your current paid advisors may be too close to the issues and be perceived as biased. So you must look for a competent outsider.

Step Two: Open up lines of communication. The consultant should interview all family members to find out their needs, expectations, and concerns. Then this information should be shared with the group so all of the issues are on the table. The presence of an objective outsider will help to convince everyone that their needs and concerns will be addressed.

Step Three: Obtain a formal valuation of the business. A valuation, by an expert selected by the group of partners, is crucial to establishing a fair market value of the business before the negotiation begins. This may seem like an obvious step, but but many times it becomes the stumbling block to an agreement. The retiring owner insists on a value that is higher than what the remaining partners are willing to accept. The partners cannot find a valuation expert that they consider independent, or they are simply unwilling to lay out the cash to pay for one. Each therefore comes up with his own estimate of the value, which almost never is close to that of the other partner.

Step Four: Work out ownership issues first. Before tackling leadership and management issues, the partners should call all their advisors together to deal with the ownership transition, At this stage, the partners must insist that the advisors work together to complete a tax-effective buyout package as expeditiously as possible —- no prima donnas allowed. If a retiring partner is to be bought out, the components of the package might include a down payment; a covenant not to compete; installment notes, and other financial tools. If ownership is to be transferred to family members of the retiring partner, a gifting-income plan should be developed with similar components.

One of the most difficult issues in the negotiation arises when senior partners own equal amounts of stock but one has more family members working in the business than the other. Some partners in this situation will decide to keep the same ownership percentages for each family, despite the imbalance in participating family members. Other partners will decide that the successors will be equal owners—as they were. In such cases, the consultant and other advisors must present financial transfer options to accomplish this goal. For example, the partner who has more children in the business may have to buy some shares of the other partner in order to give them equal shares.

My experience has been that the ownership split will not be difficult to work out unless the partners have a history of significant conflict. In businesses where the partners have been unable to get along for a long time, it will probably be too late to resolve their grievances and achieve a reconciliation. In these cases, ownership should probably remain divided more or less the same in the new generation as it was in the past; otherwise one family has to buy out the other entirely.

Step Five: Provide employment security for members of the retiring partner’s family. When one partner retires, generally the remaining partner will assume leadership of the company. If children of the retiring partner remain in top management positions, the company should agree to an employment contract that spells out their responsibilities and compensation and protects them against arbitrary dismissal. The agreement may also provide for a severance package and a covenant not to be compete if the children leave the company.

Step Six: Select next-generation leaders. The partners have to develop objective procedures for selecting a successor, so they can support the person chosen unequivocally. To help clients with this, I suggest use of a leadership assessment tool developed by consultant Harry Levinson of the Levinson Institute in Cambridge, Massachusetts. Levinson’s method, described in the July-August 1980 Harvard Business Review, describes 20 criteria for assessing leaders, including capacity for abstract thinking, judgment, tolerance for ambiguity, stamina, sensitivity to the feelings of others. (“Criteria for Choosing Chief Executives,” Reprint No. 80410.) To this checklist, the partners should add descriptions of the technical skills needed in their particular industry.

Running a business can be a lonely and frustrating experience. Having a trusted partner with whom to exchange ideas and share responsibility can be very helpful. Those partners who have clearly defined roles, who communicate well, and who share the same vision of the future can work together very effectively. They can, moreover, bring in members of their respective families to provide the committed talent needed for further development and expansion of the business.

Randy Bliss is president of YHB Consulting in Farmington, CT, advisors to family businesses on succession and strategic planning.