NO. 13: LEARNING TO BE GOOD STEWARDS OF OWNERSHIP (from Lesson No. 23)

The internal Succession Plans addressed in my new book, Building With the End in Mind, focus on gradual, ownership transitions from one generation to the next. The incremental nature of the process means that the founding owner(s) and next gen owners must learn to work together, side-by-side for, perhaps, decades. As in any relationship, compromise and understanding are necessary from both perspectives to make it work well. Learning to be a good steward of ownership literally applies to every single business with two or more owners, regardless of age or experience.

In the relatively small Successor Teams we’re talking about in most Professional Service businesses (just two to five next gen owners in many cases), each owner depends on the other owners for their livelihood and to safeguard their career-length investments, and, eventually value realized. The purpose of this blog post is to help you understand that this interdependence is a strength, and not a weakness, when handled properly.

Along the pathway to Business sustainability, life happens and owners are not always able to finish their commitments all the way through to their own planned retirement. And sometimes partners don’t enjoy working with other partners years later and they choose to leave. My focus here, and introduction of this stewardship concept, is on owners who choose to leave voluntarily and probably on relatively short notice for whatever reason. Though even a basic Buy-Sell Agreement will help address these matters, there are additional steps that can and should be taken to memorialize reasonable expectations and obligations in a well-run Professional Services business.

In my experience, being a good steward of ownership is about setting up a business’s unique and specific operational documentation to address not only when and how owners may step out of the Equity circle and relinquish their ownership interest, but to encourage good behaviors that benefit all in the long-term. Starting with managing expectations and then proceeding to the mechanics of the process, every owner wants to be able to sell their equity interest, someday, at Fair Market Value (FMV), for cash, at long-term capital gains rates, and walk away from any and all personal guarantees and business related obligations. Those are reasonable expectations for every owner if, and only if, the withdrawal is managed properly.  

Moving into the mechanics of the stewardship process, the owners of a Business should sit down and agree, as a group and in advance of any issue, that in order to meet an individual seller’s expectations when selling his/her equity interest, there should be established and reasonable expectations in return from the remaining owners. For example, a common stewardship requirement might be that a seller must give at least 24 months of notice (you can increase or decrease this timeframe to fit your needs and situation) prior to quitting or withdrawing from the equity ranks in order to obtain his/her full value and payment terms. In the event an owner leaves and wants to sell his/her equity on just two-week’s notice, for example, then the FMV of their equity Interest will be discounted and payment terms may be applied through Seller Financing and a five to seven-year promissory note rather than a lump sum obtained through bank financing. These rules, of which this is one example, are put in place to ensure that the Business remains liquid and sustainable, and that the business has time to address the loss of talent. Such rules also discourage quick changes in direction by any one owner that might result from a disagreement or argument with the other owners.

Stewardship rules compliment the more black-and-white, mechanical terms of a Buy-Sell Agreement which tends to focus on death/disability events at one end, and the long-term Succession Planning needs at the other end. In this middle position, stewardship rules ensure that all owners, whether leaving or staying, respect the business and the remaining owners who must continue to serve the Professional Service business’s client base. These evolving rules might even include a requirement that G1(s) or founding owners cannot hold more than, for example, 50% of the equity interests in the Business at age 60, and no more than 25% of the equity interests by age 65, and must sell, or offer to sell, all of their equity by age 70—adjust the numbers and ages for your situation. The idea is that putting stock into play at set, predetermined intervals helps to ensure that the next generation plans for, and can make, the necessary equity investments during the course of their careers. It also makes certain that the business does not have to deal with buying out a single, large, majority shareholder of a valuable business suddenly and completely in the future.

These rules, along with all the buy-sell provisions, should be reviewed every couple of years by all the owners, especially as the business grows in value and the owners of significant amounts of equity get older. It also is easier to document all this from the outset, while everyone is getting along well and are focused on the future and all the opportunities it may bring. In time, good rules of stewardship become a part of a business’s culture of sustainability.

Thanks for reading,

David Sr.