Like death and taxes, ownership transition is a sure thing that will happen whether or not you plan for it.

We've all heard the old adage: Nothing in life is certain but death and taxes. From a business point of view, you can add ownership transition to that list.
·  A business can transition successfully or it can transition out of existence. But either way, you can be sure that it will transition.
·  Never thought about it in this way? You're in good company. Most owners of privately held businesses don't think about ownership transition as an inevitable event, despite the fact that the majority would tell you that, at some point, they expect to realize the fruits of their labor and “cash out.”
·  Well, just like death and taxes, ownership transition is a sure thing. It will happen whether you plan for it or not.
·  Most owners of privately held businesses, in particular, fail to plan properly for ownership transition. Studies have shown that almost 70 percent of businesses fail to make the transition from their founders to the second-generation of ownership and almost 90 percent fail to make it to the third generation.
·  Nearly half (49 percent) of all executives who responded to the J.H. Cohn LLP Business Owners Checkup 2004-05 survey said they believe that having an effective succession plan to ensure a smooth transition to the next generation of owners is important to the future success of their business. Second-generation privately held companies (65 percent) are more likely than first-generation privately held companies (44 percent) to share this point of view.

Aside from starting your own business or buying into an existing business, the decision to sell and to whom are two of the most important business decisions that an owner will ever make. So, why do most owners fail to give ownership transition planning the same degree of importance as the operating decisions they make on a daily basis?

Many business owners fail to plan for ownership transition because they truly believe that the moment they decide to sell their business, there will be interested buyers - internal and external. Although this is true in some instances, it is not true for most. And, even when there are ready buyers, without a plan, most owners will fail to maximize the value of their ownership interest.

Emotional, Optimistic, Unprepared
Other common reasons why owners are reluctant to plan for ownership transition include:

·  Emotion - It is difficult to discuss one's mortality. For entrepreneurs, the idea of replacing themselves, or of having someone else run the company they started or nurtured, may be more difficult.
·  Optimism - They are overly optimistic about the ease with which they can sell the firm, internally or externally, or how long they will be willing or able to work.
·  Control/accountability - Most owners do not want to be accountable to anyone else, so they prefer to delay the ownership transition until they are ready to cease being active in the company.
·  Confidentiality - Many business owners keep their plans and the company finances close-to-the-vest and are not anxious to share financial or other information with potential new shareholders.
·  Mentoring - Many business owners are not good at mentoring or training, so they fail to groom and may have difficulty identifying potential future shareholders who they believe could succeed in buying them out.
·  Alternatives - Many business owners devote a significant portion of their lives to nurturing and growing their business and don't know what they would do if they were not running the company.

If you don't have an ownership transition plan but you know that you need one, where do you start?

Objective of a Plan
No project can be successful if it does not start with clear objectives. Ownership transition is no exception. Developing a detailed set of objectives and ranking them by order of importance will greatly assist you in choosing among the various options that you have available as you construct your plan. Common objectives include: ·  Rewarding the existing owners for their financial investment in the firm.
·  Allowing the existing owners to convert a portion of their equity investment in the company to cash and diversify their personal assets while still maintaining control of the company.
·  Providing an opportunity for key employees to become owners and share in the future financial success of the company.
·  Using the ownership transition plan as a tool to attract new employees to the company by providing them with an ownership opportunity.
·  Creating an internal market for the company's stock to generate continuous demand and perpetuate the ownership transition process.
·  Providing for a gradual buyout of the existing owners while maintaining adequate cash flow to support the continued, profitable growth of the company.

Future Shareholders
Once you clearly outline your objectives, the rest of the plan can be developed. The steps in the process include:

1. Defining the objectives of the plan, as outlined above.
2. Developing the selection criteria for potential future shareholders. Outline the key personal and business attributes that employees should possess before being given the opportunity to become shareholders.
3. Developing a process for nominating and ultimately choosing future shareholders. Once the list of potential new shareholders is developed, how will you go about selecting the employees who are actually offered the opportunity to buy into the company?
4. Determining the method for valuing the company's stock, and an initial value for the stock.
5. Developing a schedule of the repurchase obligations for the existing owners.
6. Developing financial projections. Not only are the projections necessary for the valuation, but also to lay out the financial impact of the existing owners' repurchase obligations on the company and the amount of new equity that will be required.
7. Developing a formal incentive compensation plan with funding mechanisms tied to performance as well as ownership. Potential new shareholders need to understand the magnitude of the incentives and how they can be used to repay the loans they secure to buy into the company or to purchase additional shares after the initial buy-in.
8. Developing an ownership transition summary plan description. Many owners that we have worked with think legal documents (i.e., the buy-sell agreement or an employment and non-compete agreement) are enough. Although they are important, they are not enough. Employees need a clear, non-legal description of the ownership transition plan.
9. Developing the related legal documentation, including an offering memorandum, shareholder buy-sell agreement, and employment and non-compete agreement, once the ownership transition summary plan description is complete.
10. Developing an employee presentation and holding meetings with the prospective new shareholders to sell the plan. Just providing documentation is not enough. Most owners assume the prospective new shareholders will see the same value in ownership that they did, and will welcome the opportunity. This is very often not the case. The plan truly needs to be sold to the prospective shareholders for it to be successful.
11. Developing a detailed implementation plan.

Overcoming Common Pitfalls
Existing owners can do a few things to increase the chances of making their ownership transition a success. These steps include:

·  Separating ownership from management - Shareholders need to understand that the objective of ownership is to maximize the value of the owner's equity investment in the company. The objective of management is to maximize the value of an owner's equity investment in the company. Existing owners need to understand that for an ownership transition plan to succeed, ownership needs to go beyond the executive management ranks of the company. Similarly, potential new shareholders need to understand that buying into the company does not guarantee them a position or a say in the management of the organization.
·  Ensuring compensation is not tied to ownership - An employee's compensation should be based on his or her level of responsibility and authority and the employee's performance, not ownership.
·  Starting the ownership transition process while the existing shareholders are still productive and contributing to the success and growth of the firm - This eliminates the resentment that occurs when the payout occurs after an owner retires. When the buyout occurs post-retirement, it can be viewed as a financial burden by the remaining shareholders because it has a priority claim on the cash flow of the company.
·  Managing the expectations of all employees -When you choose which employees will be given the opportunity to become shareholders in the company, you are also choosing who will not be given the opportunity. Therefore, you need a plan to deal with those employees who are not chosen.
·  Ensuring potential new shareholders understand the risks associated with ownership as well as the rewards.
·  Choosing a valuation methodology - There are several ways to value a company. Regardless of which one you choose, stay consistent and make sure that everyone understands the key drivers of value and how actions can positively affect the company's valuation.

Don't Underestimate It
Most business owners underestimate the amount of time and effort that goes into developing a good ownership transition plan. In fact, it can take much more planning, employee development and personal introspection than is normally put into developing an annual strategic plan.

A typical business owner spends the majority of his or her adult life building a business. For most, their ownership interest in that business tends to represent the vast majority of their personal net worth - and something they will greatly depend on in their retirement.

Yet, most business owners fail to develop a plan that creates alternatives to maximize the value of that equity interest. For those who do, the rewards are security in retirement and the pride of seeing the company they developed survive a transition that most do not.  E+P

David Rubin is a partner, and John Macrae a practice director, with Cohn Consulting Group, a division of J.H. Cohn LLP. They can be reached at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or This e-mail address is being protected from spam bots, you need JavaScript enabled to view it , respectively.