Succession planning

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In the latest UK200Group blog post, Richard McNeilly, Managing Partner Dains Accountants, discusses the importance of planning for the future

Richard McNeilly
Succession planning in a SME business is completely different to that required within PLCs. It is much less about finding a replacement for a role but more about planning the future viability and success of a business. Yet remarkably, it is often overlooked – not least by advisors eager to complete the next deal.

In order to be successful, upcoming Director/Shareholders need support in truly understanding the commercial and financial aspects at the heart of their business. The transition to leadership is also undervalued most notably by entrepreneurial business owners seeking to sell the business to a management team – after all, they were probably self-taught? Most successful entrepreneurs will admit to many mistakes and in some cases, failures along the way and so if the next generation of business owners can learn from these mistakes, surely that can only be a good thing?

In many cases succession planning will involve a group of people with complementary skills, as opposed to an individual, which can make the process more complex and fragmented. Training and development may not be a core skill of the current owners and third-party help is likely to improve the process.

It is essential that the planning process creates an understanding of risk within the management team and that all parties recognise that it is unlikely that a management team will have encountered risk of the type they face in the future.

How do we avoid a ‘car crash’? It is a fact that too many Management Buy Outs (MBO’s) fail – so let’s apply the same logic?

1. A professional teaches a novice to drive.
2. The individual takes time to hone their skills and gain experience, independently.

The keys to the Ferrari must be earned! Running a business is a challenge and handing over the keys to a team without real exposure is fraught with risk.

Current owners should think about future skills and the management teams’ ability to learn and adapt. It is highly likely that the management team have never been exposed to challenges relevant for the future not least for the fact that it is the current owners’ responsibility to deal with such challenges!

In practical terms I believe there are 5 steps to cover before planning ‘the deal’.

1. Skills analysis by management and current Directors/Shareholders.
2. MBOs fail because of management-management and current director shareholders - discuss!
3. Directors must understand fiduciary responsibilities.
4. Practical governance and risk management – agree how this happens and expose the management team to it, as soon as possible.
5. Financial and commercial education - all directors must understand basic financial information and in particular the relationship between profit and loss, balance sheet and cash.

Perhaps the most important question an existing owner must ask themselves is whether the management team can really run their business in the future?

It is essential that the current owner can articulate the role of the board and encourage the management team to take part in board meetings prior to completing a deal.

All parties must ask themselves how will the business differ in its future state? Too frequently all parties underestimate the impact of debt on a business, in particular where the business has always enjoyed positive cash flow. The rigour of managing working capital and client risk is ever more important and the management team should feel confident that they have a plan to manage cash in the future. In addition, all key relationships should be carefully considered in order to minimise the risk of change at the top.

Inevitably, the management team will need to accept some personal risk. This risk may not be in the form of cash, but one must never underestimate the impact that running a business has on your life. Post MBO the business is likely to be financially weaker than in the past and at the very least the management team must understand that their livelihood is at stake should the business fail.

Finally, all parties should consider whether there are any major gaps in the skill set of the management team. If necessary, action should be taken to recruit appropriate individuals in order that the management team enters the transaction with the capability to succeed.

The transition is vital and there are three key stages to consider in depth by current owners and the management team.

Transition from Employee to Director - consider the impact of fiduciary responsibilities and the enhanced status of the employee. Employees may need to consider the way they behave and their impact on others. Some of the casual conversations that have taken place over a career may need to cease as the individual is exposed to senior level dialogue.

Transition from Director to Shareholder - consider the impact of business ownership on Directors, who will benefit from business success but must also consider the downside of underperformance. As an owner an individual should consider their impact on clients, staff and prospective clients and get used to the idea that they are inextricably linked with the business. There is a heightened obligation to represent the business and in many cases a need to comment on good and bad news.

Shareholding Director to Business leader - in the end someone will need to step forward and lead the business. Without leadership, businesses fail and there is no reason why management teams cannot consider and enhance their leadership skills at an early stage.

It is never too early to start the plan whether you’re selling to trade or management. However, if the deal process has already commenced then it’s not too late to follow the practical steps.

One final element can never be overlooked is that in an MBO ‘cash is king’.

Under any deal structure the business must generate cash. There are too many deals completed without full consideration to future growth and cash headroom. The business must plan to have enough headroom for growth but also with the right controls to identify problems early.

The rewards of a well planned and executed succession plan can be life changing. Why not plan, to succeed?

Tags: UK200

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