No. 26: Postponing Your Last Day

In many succession plans, G1 (or the founding owner) gradually sells their equity all the way down to 0.00% ownership at some point before they retire. The successor team of G2s and G3s are tasked with gradually buying all of G1’s equity even as, especially as, the value and price of the equity grows. Let’s explore a strategy that can rewrite these common rules and, if you like, postpone that last day for a while longer.  

A Residual Equity strategy offers a unique solution, and it provides benefits to all generations of ownership. The strategy lies in G1(s) holding on to some of their equity into perpetuity, or for the remainder of their natural lives in most cases, at which point the business redeems G1’s remaining interest and cashes out their estate at FMV at that moment in time. In sum, G1 doesn’t sell all of their equity in the course of their working career and prior to their full retirement. As a G2/G3 next gen owner, you don’t have to buy out all the founder’s equity, at least not within the typical retirement time horizon. Residual equity can change the timing rules in a meaningful way.

A typical Residual Equity strategy might allow G1 to continue to own up to 10% to 20% of the issued and outstanding shares of the business, and to continue to benefit from any associated profit distributions and stock appreciation rights. Conversely, G2/G3 does not have to worry about buying and financing all of G1’s stock, especially if they’re still paying off a loan on the previous tranche(s). And as the business’s entire client base tacitly observes the business succession plan unfolding and witnesses G1’s gradual on-the-job retirement in favor of a younger successor team, it can be beneficial to tell the existing clients, and even prospective clients, that the founder is still an owner of the business.

Some professional service business models, if regulated and needing licensure to deliver services, may not be allowed to have a residual owner unless that person retains licensure in all states where the business has clients. Always check the regulations.

Finally, many business owners start their succession plans a little too late. The point is that a shortened timetable can be rectified by using a residual equity strategy. Suddenly, the business and the next generation owners have an extra five to ten years, perhaps, to work with and G1 has some additional upside and a way to stay involved.  

Thanks for reading,

David Sr.