Prepare to Lead. Chapter 6. All endeavor calls for the ability to tramp the last mile, shape the last plan, endure the last hour s toil.

Transcription

1 Chapter 6 Prepare to Lead All endeavor calls for the ability to tramp the last mile, shape the last plan, endure the last hour s toil. Henry David Thoreau F A R MJOURNAL 15 SEPTEMBER 2003 WORKBOOK 39

2 DEVELOP THE NEXT GENERATION Business leadership transition doesn t happen overnight. Leadership is the ability to set an objective, explore alternatives, take action and change course when appropriate. Identifying one child as successor is challenging especially when multiple family members are involved in the farming operation. It may be that only one child works in the business but does not have the skills to manage the operation. You may have several children, but not all of them work in the business. And what if one of your loyal employees is the right arm of the business? The emotional strings that are tied to the decision are complex. The sentiment may cause you to make an emotional choice, rather than a business choice. Your reluctance to making a decision may result in losing a worthy successor who moves on, applying his or her ambitions to a different pursuit. The best transition for you and your successor is a gradual transfer of responsibility. Concede your hesitation to let go. Use a realistic time line for the transition process. Allow plenty of time for hands-on training. Give yourself time to pursue other ventures as you engage in a plan of gradual transition. MANAGEMENT SUCCESSION OPTIONS. There are three options for transferring ownership/management to the next generation or subsequent owner: transition to a family member, a loyal employee or a candidate from the outside. Transition planning is best initiated early in the life of the business. The ownership successor must have time to learn the role of a leader. The candidate must demonstrate leadership skills to existing employees, customers and third-party vendors. The successors must 40 WORKBOOK

3 show that they are prepared to lead the business. With adequate time and a welldeveloped plan, a new owner can gain credibility. A gradual assumption of responsibility helps all parties to adapt to the transition. As with most decisions in life, we have choices. The business can be left to a new owner voluntarily as part of a well-designed plan, or the owner can wait until he or she (or heirs) are forced to act because of death, disability or retirement. A comprehensive succession plan covers both options. Most people want to control the timing and the conditions of the transition. They want to design a plan and include a default strategy for unforeseen circumstances. If the anticipated successor is a child, one must plan for an interim manager until the child is ready. NOTES: SHARE THE ROLES AND RESPONSIBILITIES. A clear statement of management s strengths, responsibilities and capabilities reinforces the vigor of an operation. A company is said to be only as good as the people who work there. The vigor of an organization is only as good as the leadership that drives the operation. This section of the development plan is designed to give confidence to team members, support management/personnel decisions and detail some of the critical responsibilities of the management team. Management today is not a seat-of-your-pants vocation. Leaders need education and development to succeed in today s marketplace. Development programs should be tailored to serve the individual needs of managers and the specific responsibilities of their role. Just as a development plan details the systems, machinery and tools necessary to vertically integrate a market, a business needs managers with the skills and abilities necessary to handle a new endeavor. The development plan should detail the management WORKBOOK 41

4 How to Pass the Baton Imagine the succession planning process as a relay race success depends on four factors: 1. Sequence. Prepare the successor with the leadership skills and business experiences to lead the operation. Prepare the operation and the current owner for a seamless transition. 2. Timing. Incrementally pass the torch of leadership from one generation to the next over the course of a predetermined period of time. 3. Baton passing. Manage the business and familial details of the process for a smooth and seamless transition. 4. Communication. Ensure an information exchange between the senior generation and successor(s). In many cases, owners choose to communicate with active and inactive family as well. needs of the operation. It should also detail the development necessary to ensure that management is ready to succeed. Writing the management responsibility section of the development plan forces the owner and current management team to establish the status of the business and take a look at the factors that will help or hinder growth. Though we address current goals in another section of the development plan, a summary of new ventures establishes a benchmark for management development. Where is the business headed based on industry demands? If the business is going in a new direction, what kind of management structure will serve the new focus? What is the current ability, educational and skill limitations of the management team? For which business functions or operational systems are the managers currently responsible? What kind of development is necessary to improve the skills and abilities of our current management team? What kinds of management skills and abilities are necessary to manage future business operations? What is the strength of our team, and how can we improve the depth of our management team candidates? DEVELOPMENT PLANS FOR MANAGERS. After management candidates have been identified, assess their skills and measure their abilities. Share the business philosophy, ethics and vision at the outset, and observe candidates work habits and interactions with other employees, customers, and vendors. The needs of the business as defined in the business plan will focus attention on certain skills. Next, build a development plan for each candidate, which includes methods for improving management skills and a detailed action agreement in which the candidate is held accountable for improving skills and abilities. A development plan is an important component in the selection process for a manager. A development plan is an action plan that formalizes the training and development process between owner and candidate. It puts in writing what a candidate has been asked to do to prepare for a bigger role in the family farming operation. Each plan is individualized for the candidate. The specific demands of your business are unlike any other. A variety of methods should be used for the teaching and development of a new leader. Among the methods to consider: Demand outside work experience. Link to a mentor. 42 WORKBOOK

5 Allow for on-the-job experience. Participate in training at local colleges, industry seminars and workshops. Attend business planning and strategy sessions with accountants and bankers. Attend commodity, co-op, association or grower meetings. Attend personal or group meetings with advisers and experts on various subjects. NOTES: The Bridge Builder By Will Allen Dromgoole An old man, going a lone highway, Came, at the evening, cold and gray, To a chasm, vast and deep and wide, Through which was flowing a sullen tide. The old man crossed in the twilight dim; The sullen stream had no fear for him; But he turned, when safe on the other side, And built a bridge to span the tide. Old man, said a fellow pilgrim, near, You are wasting strength with building here; Your journey will end with the ending day; You never again will pass this way; You ve crossed the chasm, deep and wide. Why build you this bridge at the evening tide? The builder lifted his old gray head: Good friend, in the path I have come, he said, There followeth after me today, A youth, whose feet must pass this way. This chasm, that has been naught to me, To that fair-haired youth may a pitfall be. He, too, must cross in the twilight dim; Good friend, I am building this bridge for him. WORKBOOK 43

6 Guidelines for Grooming Tomorrow s Leaders Keep in mind that young people are not always born entrepreneurs; they need extra training and careful guidance. Here are some guidelines to remember when grooming tomorrow s leaders. Successors are not entrepreneurs starting their own businesses; successors are managers who assume a going concern with its own set of complex challenges. Entrepreneurs are risk takers who thrive on the edge and revel in challenge. Next-generation leaders must be adept at creating systematic processes, financial control and team building. Leadership does matter, for three reasons: 1. Family firms have different goals than publicly owned companies. Family operations are oriented to serve a broad set of objectives that serve familial demands and personal issues. 2. Family operations have a greater potential for long-term conflict. People are emotional beings; it is the atmosphere of the family business that causes some to respond inappropriately to disagreement and conflict. 3. Leadership succession is far more important for family firms than nonfamily firms because what is at risk may be absolute survival. Due to the personal nature of the endeavor and the breadth of family that may be actively involved, failure can be devastating especially when you consider that most family operations comprise an overwhelming majority of the family s net worth. Integrity and commitment are the most important traits of a leader. Nothing trumps honesty, hard work and perseverance. Upon entering the family business, the leadership successor must become a student of the organization learning about its value proposition, processes and people. He or she must also become a student of leadership, motivation, management and business. In preparation for a leadership position, a successor may benefit from a mentor, coach or adviser. Don t ever overlook the value of a good mentor. The opportunity to learn from the experience of another person is priceless. It increases effectiveness while stabilizing the learning curve. The senior generation must delegate responsibility and allow the successor to make decisions and suffer mistakes. Learning requires the consequence of real risk/reward trade-offs. The generational shadow of the founder may be the primary reason for conflict in a second-generation family business. The controlling generation must become mentors to the next generation, allowing them to grow in a nonjudgmental environment. 44 WORKBOOK

7 CHAPTER 6 EXERCISE LEADERSHIP SKILLS INVENTORY How ready is the next generation to lead? Leadership may be the single biggest gap in any succession plan. Use this inventory to assess a potential leader s skills, strengths and areas for growth. The results should serve as the starting point for building a development plan tailored for each aspiring leader. DOING THE RIGHT THINGS LEADERSHIP SKILLS 1. Creates and effectively communicates a clear vision. Check the box. YES NO 2. Enlists a team to achieve business/operational goals. 3. Ownership is a privilege, not an entitlement. 4. Treats partners, employees, strategic alliances and third-party vendors as integral team members. 5. Creates a positive, constructive, results-oriented working environment. 6. Recognizes potential areas for conflict and uses good leadership to minimize the negative impact. 7. Creates systems, focuses on people and generates results. 8. Knows and demonstrates that a leader s primary responsibility is grooming other leaders. 9. Demonstrates good business etiquette and sound ethics. 10. Delegates with clear responsibility and accountability. 11. Accepts criticism and uses failure as a learning opportunity. WORKBOOK 45

8 DOING THINGS RIGHT MANAGEMENT SKILLS 1. Uses action plans to achieve organizational goals. Check the box. YES NO 2. Selects team members based on their attitude first and qualifications second. 3. Performs all duties and responsibilities with an owner s resolve. 4. Is committed to professional development. 5. Demonstrates excellent financial management. 6. Looks for improvement in business systems, personnel, market development, management skills, etc. 7. Uses technology to increase efficiency, improve effectiveness and cut expenses. 8. Effectively delegates, encourages others to accept responsibility. 9. Effectively prioritizes, based on clearly defined objectives and an intuitive risk/reward measure. 10. Uses good planning, thorough analysis, goal setting, budgeting and regular follow-up. NOTES: 46 WORKBOOK You can also find this tool at m.

9 Chapter 7 A Key to Continuity If you don t know where you re going, you might not get there. Yogi Berra F A R MJOURNAL 15 SEPTEMBER 2003 WORKBOOK 49

10 CRAFT YOUR BUY-SELL AGREEMENT This document is key to keeping the farm together. The buy-sell agreement may be the most important tool for maintaining the integrity of a business entity in a succession planning engagement. Buy-sell agreements may also be referred to as business continuation agreements, shareholder agreements, stock redemption agreements, partnership liquidation, retirement agreements and cross-purchase agreements. A well-written buy-sell agreement (one that has been drafted by an attorney familiar with the laws in the state of residence) will: Prevent inactive owners from gaining an ownership interest. Ensure ownership continues after death, disability, dissolution or divorce. Provide a ready market for a closely held business interest. Every closely held business with multiple owners should have a buy-sell agreement. It provides a ready market for selling an ownership interest, establishes a valuation method and spells out the terms/conditions of purchase without placing an owner at a bargaining disadvantage. THE BASICS A buy-sell agreement is a contract that restricts a business owner s ability to transfer an ownership interest. The typical agreement provides the terms, conditions, triggering events and valuation methods within which an ownership interest may be sold. It prevents unwanted transfers and may ensure a ready market for a closely held ownership interest. All of the owners of the business agree to the trigger events that are covered by the 50 WORKBOOK

11 buy-sell agreement. Common events include death, disability, retirement, dissolution, withdrawal prior to retirement and other circumstances that may cause an owner to divest of an ownership interest, such as divorce, bankruptcy or legal judgment. Negotiating valuation methods and the terms/conditions of a purchase are important considerations in a buy-sell agreement. Common valuation methods are: establishing a fixed price; an appraisal to establish fair market value; and a formula, such as a multiple of earnings, book value, etc. Owners must be mindful that the provisions of a buy-sell agreement can be written as an option or an obligation. In other words, each triggering event will either create an option to purchase or an obligation to purchase. A new buy-sell agreement negotiated and written by the owners of an existing business should conform to any pre-existing legal obligations, such as the provisions of an operating agreement, articles of incorporation, subscription agreements, etc. The buy-sell agreement must not be written to violate or conflict with other pre-existing contracts, including franchise agreements, leases, notes and loans. Owners may need consent from affected third parties, including lessors and lenders, in order to implement the buy-sell agreement. NOTES: COMMON PROVISIONS Buy-sell agreements are necessary to restrict and facilitate an owner s ability to transfer an ownership interest in the business. Restrictions are used to prevent inactive owners from obtaining an equity interest. A properly written agreement will allow for an orderly ownership transition, facilitate a buy-sell event with minimal interruption, create a ready market for an otherwise illiquid asset and detail buy-sell procedures if a triggering event happens to occur. WORKBOOK 51

12 A buy-sell agreement may include the following common provisions: RIGHT OF FIRST REFUSAL. A provision granting existing owners, or the entity, a first right of refusal to buy a deceased or withdrawing owner s interest before it can be sold to an outside third-party buyer. A right of first refusal usually does not activate until the withdrawing owner receives a bona fide offer from an outside third-party buyer. MANDATORY PURCHASE OPTION. A provision obligating the entity, or the remaining owners, to purchase the exiting owner s interest if a triggering event occurs. OPTION TO PURCHASE. A provision granting the entity, or the remaining owners, an option to purchase a withdrawing owner s interest if a triggering event occurs. PUSH-PULL (OR RUSSIAN ROULETTE) CLAUSE. A provision in which owners agree to buy or sell their interest based on a tendered offer. EXAMPLE #1: When an owner offers to buy additional equity from another owner, or the entity, he or she must be prepared to relinquish his or her interest for the same terms/conditions as offered. EXAMPLE #2: An owner makes an offer and specifies the terms/conditions. The other owners then have a certain number of days to respond by selling their interests or buying out the offering owner s interest at the same price and terms/conditions. This provision guarantees that the price and terms/conditions remain reasonable because an owner does not know whether he or she is the buyer or the seller. TAG-ALONG. A provision that requires a purchaser to buy minority interests in the farm business for the same price and terms/conditions as a majority interest. This provision protects minority shareholders from selling their interests at less than a favorable price and terms/conditions. It protects majority owner(s) by requiring a minority owner to sell if a buyer wants 100% ownership. TRIGGERING EVENTS The provisions of a buy-sell agreement can be written to activate based on various triggering events. The owners of an operation must establish, usually through negotiation, the events that will be covered by the agreement. Among the most common events are: death, disability, retirement, withdrawal from the business, divorce, dissolution, disagreement and adverse legal action. DEATH. The sudden death of an owner will create an extreme disruption to any family business. Without proper planning and a well-written buy-sell agreement, a deceased owner s heirs may become unwanted participants in the business. Even worse, the heirs may be forced to sell their interest to raise capital to pay the estate taxes and other transfer obligations. To minimize risk and maintain the ownership integrity of the farm operation, most buy-sell agreements call for a mandatory purchase of a deceased owner s interest in the business. DISABILITY. The disability of an owner can have a crippling effect on an otherwise healthy farm operation. Owners must be careful and specific when describing what is considered a disability in a buy-sell agreement. The language of disability is subject to interpretation, so the triggering event must be clearly defined. Disabilities can be permanent or temporary, long-term or shortterm, physical and/or mental, accidental or a gradual infirmity. 52 WORKBOOK

13 RETIREMENT AND/OR WITHDRAWAL FROM THE BUSINESS. Including retirement and/or withdrawal from the business as a triggering event in the buy-sell agreement may protect the remaining owners (and hence the integrity of the operation) by restricting ownership. The agreement may provide an option, or first right of refusal, to existing owners and it should specify the price and terms/conditions for a buyout. An option is usually tied to a specified time period, and a right of first refusal allows the remaining owners to wait and see if the retiring or withdrawing owner receives a bona fide offer from an interested third party. NOTES: DIVORCE. In most cases, business ownership (even a partial interest) is the largest asset in a household. In a divorce settlement, ownership may be divided between spouses or awarded to an inactive and otherwise unintended spouse in the property settlement. A well-written buy-sell agreement will protect the ownership integrity of the operation by allowing the owners, or the entity, to purchase the contested ownership interests. DISSOLUTION, INSOLVENCY OR BANKRUPTCY AND DISAGREEMENTS OR DISPUTES. To avoid trouble and mitigate an adverse judgment, a buy-sell may use a push-pull clause (as mentioned on the previous page) for disputes, etc. ADVERSE LEGAL ACTION. If a person can no longer perform the duties and obligations of ownership due an adverse legal action, the remaining owners must have an option to mitigate the undesirable fallout. The buysell agreement should provide for an optional buyout and may even call for a lower price because of unforeseen circumstances and the tarnished reputation of the family and operation. WORKBOOK 53

14 CHAPTER 7 EXERCISE BUY-SELL REVIEW When periodically reviewing your buy-sell agreement, use this tool to identify those areas that should be included. Caution: Legal documents should be drafted by a licensed attorney familiar with the laws in the state of residence. CASH NEEDS 1. Are all owners, including spouses in community property states, and the business entity included? Check the box. YES NO N/A 2. Are there any provisions conditioning ownership/acquisition based on family relations or other factors? 3. Have the spouses agreed to accept the terms of the agreement with regard to community property/marital interest? METHOD OF VALUATION 1. If appraisal: a) Are the appraiser qualifications specified? b) Is the appraiser selection method specified? 2. If formula: a) Is the formula method clearly explained in the agreement? b) Using the capitalization method, is it appropriate to add back the owners salary and benefits? c) Does the agreement provide for arbitration to resolve disputes to avoid a costly litigation? TRIGGERING BUY-SELL EVENTS 1. Bona fide third-party offer a) Do the other owners retain first right of refusal? b) If a right of refusal exists, can it be partially exercised, or does the selling owner s entire interest have to be acquired? c) Must the offer and exercise of first rights of refusal be in writing within a specified time limit? 54 WORKBOOK You can also find this tool at m.

15 2. Dissolution due to disagreement a) Should it include a provision allowing an owner to offer to purchase the interest of another? b) If so, should it be conditional or a push-pull requiring the owner to sell or match the offer and purchase the other owner s interest? Check the box. YES NO N/A 3. Owner s death a) Does the agreement clearly state that the sale/purchase of an owner s interest is required or optional? b) Is there a provision for funding options (life insurance, promissory notes, sinking fund, etc.), and does the provision include conditions and deadlines? 4. Owner s disability a) Has disability been adequately defined (or are you using a common definition, such as Social Security) or contained in a disability insurance policy? b) Does the agreement clearly state that the sale/purchase of an owner s interest is required or optional? c) Is there a provision for funding options (disability insurance, promissory notes, sinking fund, etc.), and does the provision include conditions and deadlines? 5. Other potential buy-sell triggers for discussion a) termination of employment b) involuntary disposition (bankruptcy or insolvency) c) divorce of non-owner spouse MISCELLANEOUS CONSIDERATIONS 1. Will the IRS accept the conditions or your buy-sell agreement? 2. Do stock certificates reflect ownership/transfer restrictions? 3. For an S Corporation, does the agreement restrict ownership to eligible parties? 4. Does the agreement contain a provision binding heirs and legal bequests to the conditions of the agreement? 5. Does it include a non-compete clause for departing owners? WORKBOOK 55

16 Chapter 8 Ready for Retirement? There are basically two types of people. People who accomplish things and people who claim to have accomplished things. The first group is less crowded. Mark Twain F A R MJOURNAL 15 SEPTEMBER 2003 WORKBOOK 57

17 PREPARE FOR WHAT S NEXT A fully funded retirement plan is paramount to successful transition. When farmers discuss retirement, there is often a hesitation in their voice. It s never clear if that s due to a love for their occupation or if it s because they ve neglected to plan for the day. Retirement planning takes time and contemplation. Many owners don t, or won t, retire due to an unstated lack of preparedness. Chalk it up to a lack of planning, having no confidence in successors, no financial preparation or an inability to retire without jeopardizing the financial integrity of the business operation. Farmers at the retirement stage are typically independent and have enjoyed farming for 50 years or more. To suddenly stop farming can be stressful. Retirement is a one-way trip and it s difficult to start over again if you change your mind. THINK IT THROUGH. Take some time to detail in writing the ideal picture you want to see in the future for your vocation, your family and your financial situation. All too often, people sacrifice opportunity and falter under selfimposed constraints by thinking first and only of money. Some advisers suggest a respite from the day-to-day farming responsibilities or even an extended vacation. Planning for retirement may not be the ultimate goal but rather a response to burnout. A good suggestion is to set up a retirement option, where the farmer establishes a time line for transition and then builds a succession plan based on the chosen date. If the farm owner gets to that point and wants to retire, everything is in place to make that happen. If not, the farm owner is better prepared financially, vocationally and leadership-wise to aggressively grow the operation instead. 58 WORKBOOK

18 WHEN IS IT TIME? In thinking about the right time to retire, take a few moments and ask yourself the following questions: Will I continue to work in the business 1. or in a completely new venture? Will I do volunteer work or pursue hobbies? Assuming that a person can only play so much, what else will I do? We all appreciate time away from work and the moments of reverie that recharge and renew our enthusiasm. Though retirement sounds like a wonderful extended vacation, free time may not have the same value if there is no work to return to. As I prepare for retirement, how do I 2. want to develop my business? Do I want profitability to support expansion? Do I want maximum valuation for sale or as a family legacy to future generations? Assuming that the business is the biggest asset on an owner s balance sheet, he or she must be acutely aware of maintaining and potentially improving value through NOTES: WORKBOOK 59

19 the sale or transfer of the enterprise. Equity and earnings will enhance retirement resources, so the focus should be a combined return on investment. Have I considered alternatives to complete retirement? 3. Often, the role of owner transitions from leader to coach/trainer to assist the next generation of management. The cultural capital you can offer is priceless as new owners struggle to establish their footing. Are my children, grandchildren, loyal 4. employees and/or extended family members interested in continuing to grow the business? Extended family members and/or loyal employees often have an interest in continuing the business but don t feel comfortable approaching you directly. Make your intentions known so that others may express their interests. Do I see a financially sound retirement? 5. The good news is retirement can last 20 to 30 years; the bad news is retirement can last 20 to 30 years. Retirement income is typically a finite number, but your future expenses are a wild card. In theory, spending will be reduced, however the rate of inflation for a retiree household can be double the Consumer Price Index. A realistic rate of inflation must be factored into calculations. The rudiments of retirement planning are consistent, regardless of occupational history. The first step is to establish concrete financial goals and an option date. The reasoning behind the financial goal is self-explanatory; the option date lends urgency and sincerity to the objectives. As a family business owner, planning will center on the disposition of the operation. For instance: Do you intend to sell the company or will it pass to a family member, current employee or outside party? PLAN YOUR BUDGET. Every farmer who is considering retirement needs to complete an income and expense budget, one that takes into account the inflation factor. About one-third of retirees return to work within 18 months. That s not usually by choice; it s a necessity based on poor planning. Farmers need to determine after-tax cash flow during retirement and, if land is retained, estimate cash flows from rent. Other cash flow considerations include Social Security, interest, dividends and any IRA, annuity or pension distributions. The choice is yours. You can prepare now for the kind of retirement you aspire to, or you can live by chance, hoping that your retirement will be long and fruitful. Fund Your Retirement Life Most people don t bother to figure out how much money they will need to fund their desired retirement lifestyle; they instead design a standard of living around an allotted amount of money. There are four variables that determine the success of every retirement plan: 1. Contribution amount. How much money is being invested to fund retirement? 2. Time. Is there enough available to reach the accumulation goal? 3. Return on investment. Interest earned, dividends reinvested and capital appreciation. 4. Accumulation goal. Amount of money needed to fund retirement. 60 WORKBOOK

20 CHAPTER 8 EXERCISE READY FOR RETIREMENT? 1. Do you plan to retire? If so, when and under what conditions?what i 2. Have you considered other ventures in your vocational life? If yes, explain 3. How much income do you need in retirement? Total cash receipts: $ Total expenditures: $ Retirement deficit: $ Retirement excess + $ To calculate, use the Retirement Income/Expense tool at 4. Do you have a deficit or an excess? 5. Can you create an accumulation plan? 6. How much can you contribute regularly? WORKBOOK 61

21 7. What rate of return should you assume? 8. How much time will you allow to reach your goal? 9. Do you need to adjust one or more of your assumptions in order to realize your goal (time, contribution amount, rate of return, projected living expenses)? 10. Should you consider a retirement plan that includes employees and other benefits? 11. What one lifetime goal is not open to compromise? 62 WORKBOOK You can also find this tool at m.