Beware of Emotion During Transition Planning

Nearly four in 10 advisers say very few or none of their business-owner clients have thought through the mechanics or the wealth implications of their business succession strategies, according to a new survey report from Key Private Bank.

Talking through the survey results with PLANADVISER, Francis Brown, wealth specialist with Key Private Bank, observed the survey was fielded among wealth advisers’ business-owner clients, but the core lessons about succession planning are just as important to apply within advisory firms.

“I’m a recovering tax attorney, and so I always push that proper tax planning can prevent business owners from leaving money on the table when it comes time to transition,” Brown explains. “When it comes to taxes associated with transition, business owners most commonly leave money on the table by failing to understand the need to begin implementing planning processes years prior to exit.”

They also may fail to adequately consider utilizing intra-family transfer strategies, such as gifting and trusts, to extract the most monetary value from a business transition, Brown added.

According to the survey, a whopping 71% of advisers claim a lack of a specific succession plan is the most common logistical pitfall facing business-owner clients looking to transition to retirement. At the same time, nearly half of advisers are seeing business owners clients share “unrealistic assumptions about the business’ valuation.”

Looking deeper at some of the logistical challenges facing business owners, advisers are concerned about a lack of diversification—with many business owners having a majority of their wealth concentrated in stock of a closely held company.

“We also commonly see no written ownership succession plan—even in cases where the business owner indicates they have a specific idea about how they would like to proceed,” Brown warned. “Beyond the actual ownership transition there is substantial need for management succession planning. The owner must ensure stability of company into the future, whatever happens in terms of ownership.”

Overall, only 13% of advisers are very confident that the majority of business owner clients are adequately prepared to maintain their lifestyle in the event they sold their business tomorrow, compared to 63% who are somewhat confident and 24% who are not confident.

The Key Private Bank report goes on to suggest it is mainly “family dynamics” and/or “an emotional inability to let go of the business” that leads many business owner clients to drag their heels on doing proper succession planning and otherwise make sub-optimal decisions. 

“For example I was recently working with a guy who has one son who is a sophomore in college and another whose a senior in high school, and he has a daughter even younger than that,” Brown observed. “He has an awesome business and he wants to retire. He would love to monetize but he also likes the idea of holding onto the business and passing it down through his family. That’s a tough decision and there’s no right answer. It’s about personal goals and objectives.” 

NEXT: Considerations for an upcoming ownership transition 

According to Brown, the process of properly arranging a future ownership transition will likely take years, whether one is talking about advisers themselves or their business-owner clients. Complicating matters is the fact that the environment that makes selling or acquiring businesses more or less favorable shifts significantly over time.

“The Alliance of Acquisition and Merger Advisers just came out with a study that shows over the last 40 years, there has been a cyclical change between buyer, seller and neutral markets when it comes to independent business ownership transitions,” Brown explained. “They project that we are in the process of transitioning away from a sellers’ market and that by 2018, we will be solidly in neutral market territory, and then obviously it’s on to the buyers’ market.”

Depending on what the ultimate objective and timeline look like, Brown said it will be the rare that a business owner actually manages to get as much value from their firm as they hoped/expected at the beginning of the process.

“We are focused on talking to business owners about taking both a top-down and a bottom-up approach when building out a success plan,” Brown said. “By a bottom-up approach, I mean you need to identify how much the business owner needs on an after-tax basis to fund retirement or some other financial goal. Then the top-down approach is getting a true assessment of what the business might be worth in the real market. In the ideal situation the value extracted from the business will match or exceed the business owners’ anticipated needs.”

Of course, real-world business owners will come down at all points along this spectrum, and those who expect monetization to come up short can start taking action to maximize potential business value. This will probably be an area where the input of an unbiased third party can be invaluable, Brown added, because “business owners have a really hard time in general holding onto an objective sense of the value of their business.”

“A lot of this work will relate to reducing the riskiness of your company’s cash flow,” Brown concludes. “In any sale, the buyer will be trying to assess whether the business is really worth what the owner says it’s worth, and the vast majority of the time this calculation will be focused on the strength and stability of the cash flow and client relationships.”