Banking and Finance

Business transition

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Lloyd E. Drumm
Senior Vice President, Group Director
Capital One Client Advisory Services

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It is critical that the owners of privately held businesses understand that their business will transition, certainly at their death, and that the overwhelming majority of opportunity lies in planning for a transition while the owner is alive and the business is continuing to prosper. Many business owners have contingency plans in place that address an untimely death or disability. However, the more likely scenario is that the owner lives a normal life span and at some point will want to redefine his or her relationship with the business. This is where a “during lifetime” orientation to business transition planning can really pay off — for owners, their family, their employees and the business.

Successful business transition involves a complex matrix of interrelated personal, family, business, legal and financial issues. Also, business transition can take many forms including: changing the ownership and management of the business, retaining the business for family members, shareholder dispute resolution planning, an internal sale of the business to a key employee group or a sale of the business to a third party.

The complexity of these issues prevents many owners from taking any action at all, says Lloyd E. Drumm, Senior Vice President and Group Director of Capital One Client Advisory Services in Dallas. Others take only limited action and fail to deal comprehensively with their situation.

Smart Business spoke with Drumm about how business owners can best address business transition issues — an often difficult process that may happen only once in a business owner’s life.

When should a business owner begin planning for a transition of his or her business?

Most business owners should start planning early so that the desired transition path happens more quickly, costs less money and falls in line with a comprehensive objective set. Also, early planning usually accomplishes more.

The key resource business owners have to implement a business transition strategy congruent with their family, financial and personal objectives is time. Successful business transition strategy can take several years to successfully address the myriad challenges that integrated business transition presents. More planning time is needed when there are many objectives or when the gap between resources and desires is narrow, and less time when there are a few objectives to accomplish and many resources to deploy. Time is an essential resource for significant tax reduction.

Most business owners have primary goals that become the focus of transition planning. If started earlier, the transition could also address secondary goals, such as evaluating the ‘readiness’ of the next generation to successfully run a business, resolving conflicts among active and inactive shareholders, building a management team that will support new ownership or mentoring the family on wealth stewardship.

What penalties will a business be subject to if it doesn’t plan properly?

There are no specific ‘you planned poorly so you pay extra’ kinds of things. However, an owner can be subject to significant expenses at the worst possible time with little relief from those expenses. An example in terms of estate taxes: The government wants its 45 percent tax paid within nine months of a person’s death, so there is typically a huge scramble for liquidity by those who haven’t been preparing for that (or haven’t been finding some way to reduce the tax) — this while the company may have just lost one of its most productive members, possibly hurting the company and casting uncertainty among employees about the company’s future.

Is strategy formation different if the business owner plans to transition to family members versus to employees?

If the business owner plans to sell to a long-term partner or to an unknown third party, a different — and possibly less complicated — strategy matrix may result than if power is being transferred to someone new, such as the owner’s adult children or key employees. Strategy will escalate if the owner’s financial or personal happiness hangs on a successful power transfer.

The critical question here is: Can the business support a significant, nonperforming stream of payments and continue to compete successfully in the marketplace? The answer requires management evaluation and precise financial modeling.

What issue do you consistently encounter that can be a major roadblock to successful business transition strategy?

Many transition strategies fail to balance the current and future needs of the business with those of the owners. Considering family business transition, it doesn’t make a lot of sense for the owner to enact strategy that ends up critically burdening the company into the future. Superior transition design can balance these two critical objectives and prove successful in delivering the needs of both the departing ownership and the ongoing business.

LLOYD E. DRUMM is Senior Vice President and Group Director of Capital One Client Advisory Services in Dallas. Reach him at (972) 855-3699 or lloyd.drumm@capitalonebank.com.