Understanding an entrepreneur helps explain why so few create and/or execute a succession plan.  Business owners have some dominant feelings that drive them into business in the first place.  Those same emotions create conflict, indecision and procrastination when it is time to plan an exit.  To begin, let’s review why people are motivated to act.  Typically, they are moving away from pain, fear and the unknown; or they are moving toward gain, pleasure and piece of mind.  The strongest emotions come from the dark side better known as pain, fear, and the unknown.  A person will fight twice as hard to hold on to a dollar that is being taken away than the fight to earn a new dollar. 

Ask yourself how is an entrepreneur different from a normal person?  Most people will describe an entrepreneur as a risk taker.  However, entrepreneurs do not view risk quantitatively or statistically, but believe that their skill and effort directly affect the outcome of any venture.  Entrepreneurs also rank passion and commitment combined with the need to achieve high on the list of important traits.  For entrepreneurs, the process or activity to accomplish the goal has little importance compared to the sense of achievement. 

Entrepreneurs also suffer from the “believe disease.”     The believe disease starts with a plan, whether it is committed to paper or just memory.  Once the entrepreneur has a taste of success, he or she is hooked.  Minor set backs are forgotten as soon as the next achievement is accomplished.  Like a dollar that is being taken away, most entrepreneurial business owners will place a higher value on their businesses than any outsider will, and parting with it feels like selling their own children. 

Successful entrepreneurs live in a world of plenty as opposed to a world of scarcity.  How could any one risk his or her life savings on an unproven business theory?  They believe beyond any doubt that they will make their ventures successful, and if (for some reason outside of their own control) it were to fail, their losses will easily be made up in the next venture. 

Thomas, the owner of a niche medical practice in Springfield, Missouri; was motivated by his family’s genetic history (males were known to pass away prior to their 65 birthdays) to sell his practice at the age of 61.  With perfect health and a zest for life, he retired from his 30-plus year business as part of his original plan.  He pledged to his wife that they would spend the next few years fulfilling their lifelong dreams.  Different from most business owners, Thomas had diversified his assets by purchasing a number of shopping centers, stocks and bonds.  Thomas had planned his financial retirement assuming that he would never sell the practice.  As well thought out as the 35-year-old plan was, when the time came to exit he wasn’t able to cut the strings.   He started down the path to sell the business and stopped just before “going to market.”  Many of his patients depended upon his personal service. He believed that no one in the state would maintain the level of service he delivered to his patients who were like family members.  Thomas took an additional year of soul searching before he could bring himself to put the practice up for sale.

Ed had a quite different problem.  He had worked most of his adult life as an employee.  Starting as a janitor for a shoe manufacturer, he worked his way up to a supervisory position.  In the midst of the company’s reorganization, Ed, age 55, struck out on his own.  He opened a specialty shoe manufacturing business that had people traveling to Kansas City from all over the country to be fitted. Ed made a good living for 10 years. What extra profit he had made had accumulated in unreported inventory.  At age 65, Ed was ready to retire and put the business on the market.   The unreported inventory had keep Ed’s tax rates low, however, the financial offers he received on the business were based upon federal income tax profits, which were understated.  This is one owner that never had a chance to correct the financial picture of his company because Ed died unexpectedly in his sleep.

With no will and no discussion about what to do with the business, Ed’s wife and kids decided they would continue Ed’s legacy.  By the time they realized they were loosing money, the inventory was depleted along with any chance of selling the business.  It was liquidated for pennies only after driving an emotional wedge between mother and son because of disagreement about how to run the business.  Belief, pride, grief and stubbornness took the place of a good succession plan. The most effective family succession plans are those that push the children out into the job market before they are allowed to work in the family business.  If they return to the family business, they do it with valuable experience and a full understanding of the other options available to them.

In the early 1980’s John, a businesses owner, was approaching retirement.  He surveyed the landscape and found himself without a successor.  After months of internal debate he decided to sell his multi-million dollar metal fabrication company.  While in the process of selling the business, john worked with his accountant but did not involve any other advisors.  Caused in part by the C-corporation double tax, John paid over 50% of the purchase price in Federal income tax.  If the story ended here, it could be considered a happy ending.  This owner was one of the better planners.  John had put enough money away during his years of operation so that he could maintain his lifestyle for 30 years.  The business sale almost doubled his retirement nest egg.  

Then, a decade later, opportunity knocked.  John’s daughter had married a sharp young man with an MBA and a stellar corporate record of accomplishment.  Now well into retirement, John entered the composite molding business with his son-in-law.  Not just as an investor, but also as a co-signer.  The original manufacturing system was installed for just short of $2 million dollars.  Eighteen months later, the manufacturing system was still unable to produce product.  John’s son-in-law took matters into his own hands and reengineered the equipment himself.  With beautiful products now rolling off the assembly line, the next goal was to sell and produce enough product to squeeze out a profit.

Time was not John’s friend.  The delays in completing the manufacturing process had caused huge operating looses. After the forth trip to the bank for more money, John was tapped out.  Logic would have told anyone to invest a small portion of the overall estate and let the son-in-law figure out how to fund the balance of the capital needed.  Entrepreneurial logic says “believe!”  In this venture, the vision was correct. Management was stellar.  However, a miscalculation in trusting the equipment manufacturer cost the family a lifetime of savings.  How does this happen?  One day at a time!  John’s family was one of the few who did not point fingers of blame.  This type of financial calamity will normally cause the same feelings as when a business is passed down to what might be labeled as “the favorite son.” Once the transaction is completed, it cannot be reversed.  The other siblings feel cheated.  Instead of receiving financial assistance from their parents, they will be expected to help when mom and Dad’s funds run dry.  The favorite son was given money and opportunity, and now everyone has to pay for his mistakes. 

“Father Time” caught up with John.  He was the same person that, against all odds, built a multi-million dollar operation. Helping his son-in-law should have been a breeze. The two were never in conflict, but the more John tried to help, the more he was reminded his body and mind had both retired.  He could not make a valuable contribution to organization and could not keep up.  John’s hind site focuses not on the money that was lost, but his sense of letting his family down by not being able to contribute the necessary energy to make the business work.

Doing it right

Four partners started a distributorship in Kansas.  From its inception the business was profitable.  As each owner reached retirement the company bought their stock.   The financial piece of their plans worked without a hitch and Ken, the sole remaining owner, orchestrated a similar financial succession.  He had gifted 50 percent of the stock of the company equally to each of his four kids.  The oldest son and the second son-in-law both worked in the business and wanted to continue.  Ken, like most fathers, had never let go of the financial management of the company and for good reason … he was not about to sell the business to the boys because of lack of experience.  The distribution company had profits that exceeded $1 million per year, which made it very difficult for the boys to financially afford the company.   

What motivated Ken to sell the business?  Stress and pressure were the words used to describe how he felt.  Though he had more than enough money and management to run each facet of the business, he couldn’t turn it over to his sons without continuing to feel the stress and responsibility of the business.  Ken had a history of heart disease and was up to 13 nitroglycerin tablets per day.  He was compelled to treat the non-employed family members the same way as the employed.  An outside buyer was the only option.

The business was put on the market.  Both boys were involved with the buyers as they were introduced to Ken.  The first buyer declined to make an offer citing that the management team was not strong enough to run the business.  Ken immediately recognized his shortcomings and brought in a consultant to accelerate the boys learning process.  Within three months, the business was sold to a private investment group who bought the company as a result of the strength of management.  Both boys retained their ownership with incentives to earn up to 25 percent of the company.  Ken was able to immediately cut back to three nitroglycerin tablets per day.  Eleven years later Ken leads the life of a relaxed retired man and the boys have doubled profits and run the operation autonomous from their financial partners. 

The examples used in this article were selected to show what happens when an entrepreneur does his or her own planning as a reaction to an event or health constraint.  The best time to plan the transfer of a business is within the first year of the business.  It should be a part of the annual business planning exercise and should include flexibility with several options.  For those who will not make it a part of their annual business planning regiment, they will have to wait for “Father Time” to tap them on the shoulder.

Rick Dillon is the managing partner of Vercor’s Midwest office.  He can be reached at rick@vercoradvisor.com.