“Give me six hours to chop down a tree, and I will spend the first four sharpening the axe.”
― Abraham Lincoln
Your company is built to last. But when you are ready to step back and let go of the reins, will the next generation preserve your legacy?
Many times my clients owning a closely-held company or family-owned business have shared with me their hope to ensure a successful transition at their company to future leaders. And as a litigator, too often I’ve seen shaky succession plans fall apart, forcing my clients to dismiss potential future leaders and reinsert themselves into the day-to-day operations of the company.
Succession planning is a vital part of your estate planning process, and one of the best ways to avoid estate and trust litigation is to have a clear and comprehensive plan.
Numerous studies have confirmed, however, that while most business owners agree succession planning is critical to their company’s success, most businesses lack a clear plan. According to a December 2010 survey of 1,300 companies from leadership development firm Korn/Ferry, 98 percent of companies regarded CEO succession planning as an important part of their corporate governance, but only 35 percent of respondents acknowledged having a succession plan in place.
Likewise, Forbes has reported that at the 1,000 largest American companies (by revenue) in 2008, of the 80 new CEOs appointed only 44 of them were promoted from within, suggesting that far too many succession plans are not working.
Studies suggest that small or family-owned companies are even less prepared, which may explain why only about 30% of family businesses survive into the second generation, 12% into the third generation, and 3% into the fourth generation.
As the generation of baby-boomers continues to transition, now is the time to develop a plan. About a trillion dollars of small and mid-size business assets will change hands in 10 years.
Notwithstanding the urgent need for planning, a May 2015 follow up survey from Korn/Ferry demonstrates that not much has changed in the last 5 years, as only 32 percent of business leaders surveyed believed their organization was doing a good enough job cultivating “ready now” leaders.
Given the need, succession planning advice is a cottage industry. Consulting and leadership professionals offer general advice about how to begin formulating a succession plan, including developing a clear vision of where your company is heading, identifying and assessing potential new leaders, conducting stress tests of the new structure, and writing it all down in a succession planning document – all good advice.
But when you are developing your succession plan, consider adding to this general planning some specific legal devices to help implement your plan and protect your investment in your company’s future leadership. Here are some tips for achieving this goal.
1. Protect Confidential Information
As you bring future leaders into your inner circle, they will have increasing access to your company’s confidential business information. Protect this information by having your future leaders sign written confidentiality agreements. This will help prevent a future leader from taking your confidential information, such as pricing or client contacts, to your competitor or making your information the foundation of a new business the future leader starts. Having your future leaders sign a written confidentiality agreement will help make them aware that confidential information is valuable to you, and by being more aware they may take additional steps to ensure they are not putting your information at risk to inadvertent disclosure or cyber threats.
Your confidentiality agreements could broadly define the employee’s obligations, specifically name, without limitation, the confidential information you are seeking to protect, and set forth the mechanism for enforcement of the agreement upon a breach, especially in cases where monetary damages are hard or impossible to calculate
2. Be Smart When Giving Away Equity
As an employee moves toward becoming one of your company’s future leaders, you may consider incentivizing the employee by allowing him or her to participate in ownership of the company. Make sure that when giving away equity you understand whether, and to what extent, you are ceding control of the company.
Ownership structures can help clarify your rights in company control. For example, you could consider creating a class of voting stock and a class of non-voting stock. Giving future leaders non-voting stock could allow them to participate in ownership of the company and receive the financial reward of dividends paid. Your retaining the voting shares, however, could give you the continued right to control the company. Similar structures exist for limited liability companies or partnership, in which members could own the company, officers could be appointed to manage the company’s day-to-day affairs, but managers or boards could be appointed to control the company’s corporate governance.
In a written agreement with a future leader giving them an equity interest in the company, you could specifically state what happens if the employee leaves the company or experiences a life event. This could help you avoid litigation involving a former employee’s rights to company information or cash distributions, or a situation where an employee’s ex-spouse receives the employee’s company stock in the divorce and now claims a right to sit on your board.
3. Protect Your Business And Clients
You could encourage your future leaders to stay invested in your company by creating disincentives for their leaving. Properly written non-compete agreements could impose a legal obligation on your former employees not to be engaged in, or assist others in, a business that competes with your company. Likewise, properly written non-solicitation agreements could impose a legal obligation on your former employees not to solicit your customers for business. Without these protections, a potential future leader might be able to pull the rug out from under your company, just when you expected the employee to be part of the leadership team taking the reins from you.
4. Integrate Your Succession Plan And Your Estate Planning
Consider making sure your estate plan works in conjunction with your succession plan. You could establish a trust, which, in addition to potentially providing tax planning, could name a trustee to administer your assets in the event of your disability. If your shares of company stock are owned by the trust, your trust documents could provide specific instructions to your trustee regarding how to administer or vote your shares. Likewise, when appointing an agent authorized to conduct your business pursuant to a power of attorney, consider incorporating into the documents specific authority and instructions regarding your company stock.