meRIT Webinar: Ego, Family, Death and Taxes Planning for Business Succession 20180927 1603 1
Well, thanks this is mark blood Thanks Thank You Lydia thank you Dan for for. Having me come in and speak today I as. I was walking onto campus today I was, thinking about planning, my own, succession. I. Don't, know how many of, you have, recently been on campus at RIT but this. Place is a lot cooler than, where I went to college and. It. It. Might be nice to have a segue. In my life where I go back to being a college, student at this point in time so. Lifelong. Learning. That's. Exactly, right so. So. Thank you again I'm. I'm, I, guess I'm honored to be here. With Dan. From. The perspective, of he has a lot more knowledge than I do and, a lot more life experiences. That I have not calling him older and I visited a that just means I'm older but I'll get into that shortly. So. So today we're going to spend a little time talking about some. Of the things that that, we see in the succession, planning world and the. Very first slide that you, see is it says -, what is succession, planning principally, refractive. And there's. A big, set of words. Underneath that that says business, valuation. So. Literally, this morning I had an. Interesting interaction, with a client, of mine as. As many interactions, with clients start they start with a text message saying hey can you give me a call I need to talk to you about something, I don't think anybody calls anybody cold, anymore in this world you. Get the you, get the prep text message and. So. I so I called my client back and he. Tells me a short, story about the fact that he had taken his father to the doctor the other day and, the. Doc after he got done with his doctor visit doctor his father sits down in the car and looks over at him and says hey you need 10 million dollars to retire on nowadays how you doing toward that and. It. Started, it on the conversation. He's a guy who is in his late 40s, he has two kids who may at. Some point in time end up in business, and. Ask. The question about you know how do I begin to plan for my retirement and the first reaction, that I gave to him is that well. One of the things we principally, need to figure out is, how big the pile of money needs to be and, you. Could see he was kind of cross-eyed, on the other end of the phone even though you couldn't see him.
Because. What, I was really asking him, was. For you to be able to lead. A retirement. The way you want to lead your retirement, how. Much money, do, you need to have at that point in time in order to be able to fund, the. Cash that you need to live on and. He. Thought that was kind of an interesting way to go about it because, he. Always thought the that retirement planning would be the other way around you determined, how much money you had and then you thought about what your your lifestyle, was but, really what it's about is, determining. To, a great degree what your lifestyle, what you want your lifestyle, to look like in retirement, and then. Begin, to back into, what you would do from a succession, planning perspective in order. To be able to support. That. Retirement, and with. Many, people, who, own businesses that are trying to plan their so their succession, one. Of the biggest issues they have is, business. Valuation. How, do they promote, succession. In their, business, in order to be able to, enhance. The. Business the, value of their business. So. We're, going to spend a fair amount of time today kind of talking about some. Of those issues and, you. See in the next slide basically, I asked the question what promotes preserves, and enhances business. Valuation. And to. A great degree we're going to talk about some of those things that, kind of I guess, I would say begin to speak to the question, of how, big the pile of money needs to be it sounds. Like kind of a backwards way to go about it but many of the topics that we're going to talk about are, going to be topics, that hopefully. Give. People some insight into how they can enhance, the value of their business so. That as they look, through to their retirement, and they look through to the succession, of their business, they, can can. Develop some takeaways, in some strategies, to be able to, pull. Off a successful transition. So. So in the slides we're going to talk a little bit about management. Succession. We're going to talk about. Leadership. Or governance. Succession. We're, going to talk a little bit about financial. Strategies. What you should be thinking about on your financial, statements, we're, going to talk a little bit about some family business concepts. And then in the end we're going to talk about a few hard topics, and I think probably many, of the hard topics, Dan has seen in. His days of board governance, where. You, might have fellow. Directors, that are like me that's a real hard question, yeah absolutely a mark and, good, afternoon everyone, unless. You're in a western time zone then good morning, okay.
So Mark. Mark is. Going. About this in the context, of what I would consider to be an. Organized, transition. Or a plan for transition. Or succession. My. Experiences. Are, first. Of all I had three CEOs, died, while. They were in office and, one. Board we fired one that required, succession. Of course and in. Other cases it, simply was a matter of selling. The business and, deciding. Okay, who's. Going to succeed but from, my world the. First and foremost responsibility of, a board member is to hire and compensate. The CEO, which, of course means, if the CEO is gone we're. Back at it higher, and compensate, the new CEO, figure out who it is that's, most qualified, to, take over the reins so there's sort, of a lot of tentacles, to. The possibilities. Here regarding. Succession. Planning but I think. In Marc's world it really is about privately. Held companies, and normal. If you will if we can use that there's such a thing transition. Planning, not, not a pleasant thing for many boards, and businesses, to talk about actually, it, makes, probably an interesting sight, way into the next slide that you see that talks a little bit about management. Succession. One, of the topics that Dan brought up is succession, at the at the CEO level and. That succession, comes in lots of different ways it comes because you. Have a great CEO who someday says that they're going to retire or you have the CEO that you walk in some day and say you're going to retire today, and, and, all those things happen, in a myriad. Of businesses, from a business, that has five million dollars a year in revenues to a business, that has five hundred million dollars a year in revenues I think, Dan it's fair to say that those CEOs, that. Are the ones that are the great CEOs, those. Are the CEOs who we'd rather. Than tell and what I mean by that is, they're. They're. The guys who are out in front of where the business strategy is, they're the guys that are showing. People the way to promote value, in the business rather, than telling people what to do, and. I think there's a difference, in those CEOs, III. Do to mark I think the, legacy, of the, of the successful, CEO, is that, they delegated, to very talented people, the. Responsibility. To run the day-to-day activities. Of the firm and that they really oversee, like, an umbrella the whole environment, not. In, any dictatorial sense, it just doesn't, work in today's world, so. So. That's, really what boards. Are, thinking, when they talk, about all right if, our CEO, isn't with us what, do they leave us with and how, do we move on from there so oh yeah.
There's There's, these leadership, styles, that are critical, to the succession, planning, so I thought I thought it was interesting and really, the next bullet here is about talent, talent and talent so, I mentioned. As. We were chatting before we started on this that I spend spend, a little bit of time doing some podcasting. And I also listen a lot of podcast there. Was an interesting podcast, that had a, interview. With Indra Nooyi was, the outgoing CEO, of, Mexico, and she. Made an interesting comment, and basically, said I'm the day that I became the CEO I, was, working on replacing myself, and I was working on collecting the talent, to, be able to replace myself and that. Really to me segues. Into, the. Next two slides on, who is next and who is not next the, I think the interesting part about that when you look at management suggested, succession. Is. Oftentimes. The, see the. CEO, and, the other people that are in the c-suite look. At themselves. As being who's next. Rather, than the collection, of talent, being, who's next and the, great CEO, and, those great people that are in the c-suite are actually. Identifying. The people that. They've surrounded themselves with, as being, who is next because I, think in reality in, most instances, the, CEO, that you just hired is not, up next, and, the. Reality, I think that comes along with that is is, the. Ego, part of, what, we put into the title, of this. Presentation, and and, then I'm sure you've seen some of those egos, and you've seen people manage, through through. Those easy yes and, some. Of the worst stories, that I recall. Our CEOs. Talking. To the board well. What are you going to do when I'm gone this is this place is going to fall apart and I'm like you're a bad CEO, you should be seeing to it that when, you're gone the. Transition, will, be as seamless as it possibly can, be and. So I'm very sensitive, to that part of that slide. Regarding. Who's next and who is not next and you. Know there are thousands, as we know of privately, held businesses. That, are right in marks sweet. Spot that, don't really have boards, if you will they might have advisors, but mark becomes, the adviser, they're accounting, a.
Professionals. Become their adviser but in my world where, the board is more formal. That. Who is next, that is an executive, session, issue that, must be addressed because. This mark said a lot of people might be in the in, the room and a normal board meeting think they're all going to be next and it just doesn't quite work like that well and. One of the one of the things that often times comes, when you're trying to identify who's. Next especially, when you talk about family, business, situations. Is, you. Oftentimes, have a parent, who's, sitting and having a conversation, with their their son or their daughter and. The. Parent. Is oftentimes. Having a hard time trying, to figure out whether their kid is really next and I literally. At times have conversations. With my clients, to say you're. Looking. At your child as those is them. Being the person that you change their diapers, 26, years ago and the. Reality, is you, need to determine, whether, they're truly, an adult and truly a professional, who can be a part of who. Is next and sometimes, sometimes. Your children, are not who's, next right, and the, the, person who has, truly. Compartmentalized. Their. Ego, and has, compartmentalized, how. How this, plays into their business, sometimes, has to make hard decisions that, their family member may not be who's next, and Marcus it's a two-way street isn't, it I've, been in situations, of privately held businesses, where. The parent. Or the founder. Has. Built a beautiful company, and the, children have said point-blank I don't want anything to do with it so we. Got to go, down another path and of. Course here. We go how do we that's funny both of my kids said oh you're going G to be an accountant I don't, sell it so it can happen. Both. Ways and then in the meantime it's, going to happen is I think a big point of this a, webinar. And if it's going to happen how do we do it most effectively, to protect the interest of all parties so. We have a. Coming, in specific. To. Privately-held. Family-owned. Companies, is it, possible, that we should be talking about, what's.
Next. Rather than who's next because the who always, means a particular person. I. Think. It's actually it's. Actually kind, of both of those mixed, into the blender, at the, same time I, guess, you could say there's analogies. With that you know different horses, for different courses you. Have golfers, who play better on on one, course versus, another course, so as, you thought about your business, strategy, and, your. Business, plan and have you matched the right people, up with it I tend. To be a person, who believes, that. Management. Team, wins. Out over business. Strategy. Any day. And. I guess another way to say that is, I think. If, you. Have an a management. Team, that. They can take a, be-. Business, plan and, turn. It into, a. Great, business, plan where. If you have an a business. Plan and you, have a b-, management, team you're. Probably going to take an a business, plan and turn, it into maybe a c so, i I'm you, know I don't know what your experience is then but I'm I don't think it's a lot different than that because I know some of the companies that you've been involved in and they. Have great, management, team that. Have that, have built fantastic. Businesses, yeah of course I think you know it's really. In. My mind we, look for the jockey of, more. Than the horse so we want, good leaders and we believe they can bring. Marginal. Business. Plans to, very successful, conclusions, but, in the context, of okay we got a family business. Going. To talk about only who what about what well in the scenario that I briefly, described, earlier where. The founders, children, were not interested. The. Founder at that point put a board together and said okay advice. Because if my children are going to take this over then, I only see a sale and I don't want anything to do with the sale I want somebody else to leave the sale, I want a board to represent. Me so so, it's so. You know what's. Next is who. Or do. We even continue. In this business and. Those are those. Are pretty gut-wrenching, board. Meetings, believe me where there's a lot of emotion, at play and the, board's trying to be in its fiduciary role. Independent. If you will but. But. But, closely how business is there's, a lot of emotion, there so so. From my perspective, it's. What is next.
Who. Or what you whatever it is so I think. It can, be a, unique. Combination of both of them yeah, the. Last couple bullet points on this or less. There's. The two kind, of bullet, points that look the same on this slide experience, in time and understanding, the business experience. An opportunity in decision-making, you, know oftentimes as you look at management, succession. Management. Succession. Comes, out of the ranks of management, that you've developed, so. You, have a CEO, but you might have an Operations, person, who's, coupled up with them and, you're. Looking at the operations. Person, as being somebody who could succeed, to the CEO, role and. I think I think many of many, businesses and, many clients that I've seen struggle, with the idea of, how. Quickly, and, how soon, you. Begin to handoff. Decision-making. Capabilities. To the people that are, are. Next, so to speak and you, know the experience, and time and understanding, the business. Oftentimes. The. Founder, of the business the, significant, owner of the business what, they know about the business is almost a reflex they. Have. Things, that they think and, they know about the business that are like so ingrained into their brain that that. They just react, and they think that other people that are around, get it the same way and one. Of the things that we found in our business, is. That. We're trying to take people that are in manager, roles in our business, and they're in senior manager, roles in our business we're trying to expose, them to the decision-making, process. So they have practice. At, making. Decisions, they have practice. At. Understanding. The business, because. I think. Our fallback position. Is yeah we know that we understand, how the business operates and, we think that permeates, the organization. But, it doesn't, and I'm. Sure being like in your case you've seen those, situations. Where you, look at people, that are in management roles and you go how, come you don't get that yeah how come you don't understand, that about an alibi square packages. Into round holes and, I think there's a question up here that hits. That nail right on the head, and. So I, think. In modern. Compensation. Or equitable. Scenarios. Empowering. Employees. To. Make difficult, decisions that. Are aligned with the interests of the owners would, suggest that, those employees, have some ownership interest, that, they start to think like owners and understand, more clearly the, impact of their, decisions and, the value of the company well. If. You're a founder and, you're a hundred percent owner, this. Is like. Giving up your firstborn, to some of them that they're like wait a minute I want, complete control here, and I think it's. Really incumbent upon advisers, is that you know what you. Can have 100%, of ownership, of something worth, like say 10 million or 60%. Ownership. Of something worth 50 million and then the thought starts, to go to okay, at some point I'm not going to be here I'm hoping. For a higher value, but that speaks to business value yeah be a parable because when you thought about that you've thought about it in the son what's really, promoting, value, and I. Think the fallback position, that you were talking about is you have that founder, who, wants, control, they, want that ultimate, control, and actually, in. My experience, the more they want control the less control they have and, because. You, haven't surrounded, yourself with that talent that, really puts you into a position to enhance the valuation, of business, jack-of-all-trades and. Business, this doesn't work I mean it can work but. But it does in fact, diminish. Value in almost every case so. Lydia. Can I read the next question I can and says I've heard that some, small businesses, transfer, over from the original owners to employees, as owners, how, common, and difficult is this process I can, answer that very quickly we're, going to touch on it a little bit later. On as we, talk about financing. And transactions. And so forth how. Common, is it very. Common, how, difficult. Is it very. Difficult, and. The. Reality, is if you look at succession. And many small, and medium-sized, businesses. Right now many. Of them follow this path and we're going to talk about in, in a couple of later slides we're going to talk, about a couple of the little little love, I guess, characteristics. Of those transactions. The. Great question, by the way in and one. That and the mind of should, be on the mind of all privately, held businesses. In the publicly-held arena. It is. Common. It's not that difficult we generally do it with options, or stock.
Appreciation. Rights something. That's, observable. Objectively, there's an outside, market, but. In the privately, held business, we. Still struggle with it even in publicly who gets them so. In, the context, of this question. Transfer. From the original owners to the employees, what, employees, all, of them that's a possibility, a select, few that's, another possibility, and those, are, very. Difficult questions because, you don't want to squeeze. A few, at the expense of the many if you and you don't want to please all of them at the expense of the owner so, it's, kind of like in a using a sports analogy who, gets to travel with the football yeah and who do LCI and who doesn't suit up in the weekend is that so soil it's, a it's a very. You'll. You'll see some interesting and, hard issues, when you talk about those closely held businesses, that but in the single owner the original owner they control, so you're not going to do anything that they don't agree to right. So. So we're going to segue a little bit to corporate. Governance and succession. And. Start. Kind of at the top of the hierarchy informal. Boards, dan has a. Lot of experience, with formal, boards. That. Area, of governance. Since. The. The, Enron. World and, since, you. Know a lot, of, sarbanes-oxley. And. And so forth has been a very changed, world very, and. The. Requirement. For members. Of boards, to. Treat. It as truly, a business. Enterprise, being, a board member is a business, and you need to function like a, business, person would function it's not just, show. Up have lunch and have a drink afterwards, no it's not even close to that and, I unfortunately. Not. Old enough to know those days I imagine. It was a pretty. Easy show, but today, we. Are very, very, aware, of our, responsibilities. And our, exposure, so, you know but why would you sit on the board becomes, a legitimate, question given. That exposure and you do it because you hopefully, have a background. That. You believe, there's some prestige, to it and there's, compensation. But. All of those are, trumped, by what. Are, we doing the right thing, and. And do. We have the right people on the board. To. Lean on to. Determine, what the right thing is so, the. Formal, boards and you know I put, up there may be publicly. Held boards, which are under, heavy regulatory. Requirements. Versus. Privately, held boards, which our advisory, boards, more than. Controlling. Board. So in the publicly held arena we tell the, company the shareholders. Here's your CEO in, the private, health arena we might recommend but. The owner is still going to make the decision, and. The. Segway on that is that if you look at large. Organizations. You look at publicly, traded organizations. That really do have formal, boards. Many. You, look at many small. And medium-sized businesses many of them have informal. Board structures, they have informal. Groups of advisers I have. Clients of mind that are middle market companies that, I actually sit, on their board it's it's a board, that. Is not, imposed on, them by a corporate, governance structure, but it's a board that they want to have they, want to have that. Input from a set of advisers that. Have some deep knowledge about their business and are willing to come to a meeting and tell them hard fix yeah.
I Think they're invaluable it, says. You. Know some owners are like I'm not sure I want to share all this with without. With others but you have to convince them look this is a very effective, way to, access. Significant. Experience, and skills without. Having, to make, you. Know hiring commitment. To them this is this, is becoming more and more acceptable. And I think it's a great direction for privately held businesses, to go it and. And. That's and the Segway on that is is many informal. Boards. If. Companies. Don't have an informal, board oftentimes, they have you know a key set of advisors, and, one. Of the things that I always said in over, the course of my career was. I wanted, to be in a position this is really dating, myself but. I but, I wanted to be in a position that I was when I looked at the speed-dial, list on my clients, phone that. I was toward the top of the list I really thought successful, if I was number one but. I thought I had some level of success if I was on one of those buttons on their phone that they'd press to immediately, be able to dial. Out to somebody and. In. In the, world that we live in right now if your key advisor is your accountant. Your CPA, your, your, attorney, your, insurance, guy. Your. Whoever. Else's is influential. On your business if those. Aren't people that, you. Really, pick up the phone and call or I guess in today's world you text, in advance of making a phone call to them if, those aren't people that, you, would feel free to to. Call them up have a beer with them have a cup of coffee you might have the wrong advisors. And. I'm, sure like in your case Dan with, many of the boards that you're at there's board meetings there's committee meetings, but I think much, more probably what you did was was. An informal, phone call where they were looking up for your advice, absolutely. It happens more and more frequently. Formal. Board meetings, obviously, you don't schedule, one every week but issues come up every day so. I had a call this morning from, the. Head of internal waters of a company among the board oh I've seen, some very specific, questions about. Presentations. That were going to come up at a board. Meeting that scheduled a couple, of weeks from now and this. Is how I like to operate this there's no, barrier. If you will if, you're going to be a board member an informal, board member a key advisor it suggests you're available. Right. And and what. Really what, really sets, you apart is. You're. In the position where you're getting the phone call because, it means that as being a board, member or being an advisor to the company, you've, put yourself into a position that, you've, developed relevancy. With, the company that you're working with you develop knowledge and, you've, developed the ability to be a key advisor if, you. Don't have those whether, its formal or informal or. Those key advisers that. Have that level of intimacy. To your business, you're, in a position where. You're, not getting what you need to get out of those advisors and that really, to me kind of segues to the next point in that if you, look at all three of these bullet points formal boards informal, boards key advisors, what.
You're Really trying to do is you're, trying to establish a set of accountability, structures. The, one thing that I find with, clients, and I find in my own business, that, if you, don't have, those. Points, where you have to be accountable to someone, else I mean, I'm a partner in my firm Dan. Deals with lots of people that own a hundred percent of the company, that. That he's working, with and, those. Types of people because, they get busy at times they. Don't tend to have those accountability. Structures, around them and if. You look at the, board you look at informal, boards and you look at those advisers you, need to use them as being, accountability. Structures, outside people, that you're accountable, to that, when, you're going to a meeting with them you know you have to put up you know you have, to be able to go there and present what, you've done since the last time you met with them because. You don't want to be a bear enough. So. I I think the other thing that you. Know Dan touched on this a little bit is the, fiduciary duties. Of board, members and I, think, one. Of the, things. That is important, to understand, is that a. Board. Is not. A club a, board. Is a set of people that when you put them on the board they, have a set of duties and that. Set of duties is much. More expansive, than, what, you ordinarily think, it to be for. Instance I mean if, you look at the books and records of a company you look at their financial, controls, oftentimes. The owner doesn't want somebody to tell them that they can't spend, some amount of money on something, but. Even, as a board member you, have to hold them accountable to. Certain. Things like that because you have a fiduciary duty sitting, on their board you. Absolutely. That's next that's, the whole point, more, to. Provide some level of expertise. In a, manner that's consistent with. What we, refer to on the board our duties, of care loyalty. And. A. Good. Business, judgment if you will that's what we're supposed to bring, to. The business that. Enhances. If you will. Good. Decision-making. Outcomes. Where. Advisors, we don't run the company, and those lines are sometimes a bit blurred, but. They're but they're not blurred, conceptually. Well. One question come in so having, seen. Companies, small. Companies and, private companies break, apart, into, camp. Is it. Possible, that a, CEO. Can. Select, foreign, people, that are actually too. Close, to. Him those. Friends. Close. Advisors, that. That personal, relationship. Becomes, a hindrance I. After. The answer to that is yeah absolutely. Absolutely. You can. You. Can select somebody to be on your board that's going to parrot you that. Is going, to mimic. Your behaviors, is going. To agree with everything that, you say is is. Not going to be challenging. And. I think with with many of us the best friends, that we've ever had in life are, the, friends, that will, call you to the carpet they, will call you to the carpet because they see their, role with you as being. Much. More expansive, than rubber-stamping. And outcome, and I. Think you look for some of those same characteristics, out of your advisors, out, of your formal, board members, and your informal, board members you look, at those people that, are invested. Enough, that, they will, disagree. With you and they, will disagree, with you in a, challenging. Way that is about a better outcome and, those. Are the people that really will help you with, succession, yeah. It's, a, very interesting. Topic. I think. Everyone needs to understand, and the publicly health arena you have to qualify you have to be approved by the SEC. In. The audit committee for example, somebody's, got to be designated, as a financial, expert according. To a set of criteria. It's. Much more formal, in the privately, held arena, we, can't fire the CEO as the board they own the company all, right so so. They have complete, freedom regarding. Who, they ask or. Advise who, if they want to aboard, who, they, like to populate, the board well, of course. It's. Hard to imagine that you would put an enemy on your board all right in the meantime it's hard to imagine that you would put somebody on the board with no ability to help you and.
Those. Lines are a. Bit fuzzy but owners, we, assume, want. To do things that are good for the company, who. Goes on the board becomes, oh you know an, interesting question, because if, a, friend of mine asked me would, I be interested in a board, of. A company that, he or she is running of course I'm interested but. I'm thinking, I don't want to go what's. More importantly, your friendship, or giving, you good advice not. The easiest thing so, the Abraham, Lincoln team of rivals model. Could be good here it, could be good but a value on the company I don't want a team arrival, all, right but. I think, I think that's kind of the common reaction, the common react I know that people is is, why. Would I want to invite them into my living room and. It. Takes a it, takes a bold personality. To. Invite. Those people that are really going to challenge you hard, into. Your into. Your living room but those. Those. Challenging. People are the people that are going to put you into a position that. Promotes. Your succession, they promote the growth of your company and, they promote the outcomes, that you want which. Is kind of the, segue into, the. Next slide that we have and that is you, know planning for financial, outcomes, that. Can promote success. And, you. Know one, of the things that and obviously this is coming from one. Guy who's got CPA at the end of his name and another guy who's got CPA, at the end of his name and, you. Know we tend to like. To talk about financial, statements. And you know if if you guys really want us to we'll dive into some debits and credits for, you but I don't, think anybody, really wants that but, they. What, what this slide is about is to. Me what's showing up on your financial, statements. Is a. Huge, part of succession. And I. Think a lot of times people, that are running companies and, people that are working on operations. And companies, they, look at their financial, statements and they say oh yeah, the financial, statements, are you know we have to get those out to the bank we, have to. We. Have to report to some outside organization. And we. Have to prepare a, tax return and they. Look at they look at their financial statements and they look at the, disclosures, on their financial statements almost, as being, a. Product, under themselves but the answer, in the end is your financial, statements speak to you and they, speak to you about your. Readiness, for succession, and you. Know the things, that tend to promote succession. Is liquidity. In businesses when. When, you look at businesses. That. Lack. Liquidity. They. Lack. The ability to be able to make hard decisions because. You. Know they might not have cash, balances. That that they really should have based, on what's happening, with their business they, have excessive, inventories. They have receivables. That don't turn in the right way and, so. Therefore they haven't promoted liquidity.
On Their balance sheet when, they start to talk about succession, and they start to plan for succession. Having. Dry powder on your balance sheet and I refer to working. Capital as being dry powder having, dry powder on your balance sheet gives, you a lot of flexibility. In order to promote succession. And I. Think, that oftentimes, people. If their balance sheet as kind of being I, don't, know if the right word is penance, but. They don't look at it as being something, that's actually speaking, to them from a succession, perspective. I think, in your old Dan you know one of the things that you look at is being an advisor is to say you, know is this a balance sheet that you can go to battle with yeah. And I go right to these bullet, points might, come even. In. Sources, for liquidity, especially. A kind of debt retirement. But, we have keyman insurance for. Example in, one, of the situations. Where a CEO passed away we had a significant, life insurance, policy, this, allowed us to engage in a transition, with that with, the individuals, the state if you will regarding. Their shares that's. That's on the bottom there if somebody's going to retire what happens, to their equity position, where, does it go, are they still interested. And. You. Don't just sort of a sudden. Get, a phone call or an, email or whatever the current communication system, is that, XYZ died what, do we do now you, think about these things you plan for because, it's inevitable that. Succession. Is going, to occur, while. On your watch or you're going to be the one being succeeded, so one way or another you're, going to deal with wait we're not moving for us now I am that I think I think that's what everybody say yeah yeah yeah, the. Grim Reaper's undefeated. As we said you're right and but but there's there's there's, a million stories that, that talk about situations, where you have both planned and unplanned succession. And and. I can tell you from my experience. Whether. It's planned or it's unplanned. Financial. Resources, and liquid. Financial resources, on your balance, sheet are, a, situation. That you can go to battle with and the. Liquidity on a balance, sheet really puts you into a position where, you, have much more flexibility. To promote, a buyout. Of shareholders. Now you can put yourself into, a position that you can sustain periods, of time where. You may have down earnings. Where you may have other, challenges in the business as you go through succession, models, liquidity. Is. Is. I guess I would say that the dry powder that you really want to be able to to. Promote, and have on your balance sheets your balance sheet and your. Cash flows and your. Income statement they're always telling you messages, and they're telling you messages, about, whether you're really ready for a succession, there's. One point on here that I wanna that, I want to drill onto and it's the third one that talks about sustain sustainable. Debt structures. So. Many situations that I've seen in my career that I've seen in my client, base are, where. Businesses. Have, that, and you. Know there's there's a lot of businesses out there that have doctors, who that don't have that but. That. The sustainability, of the debt structures, post. Succession. The, succession, coming, because, you had, the founder of a business, who left or you had the founder of a business who died. People. Think and oftentimes, erroneously. Think, that when. The owner dies the bank's going to still be willing to left they're, still going to be willing to keep that 10 million dollar mortgage in place that, was guaranteed by the owner and, they. Think that the business is still in great shape and so forth lo, and behold the owner dies and, you get a nice letter from the bank and the bank says, that.
Says You, know mr.. So-and-so has, died and that's an event, of default under, your debt agreement and, oh by the way we'd like to be paid off and. You, have a default rate on your debt that is five points, higher than what it historically, has been I, bet, you've seen a couple of those all yeah this is this, is absolutely critical for, us both, from the lending perspective and, business. That borrows, perspective. You, know when is when they see the quiddity up here all right I think. It's easy to confuse this with having. Piles of, money around that's, not what we're talking about we're, talking about, insurance. Proceeds. Once again we're. Talking about liquid, access. So so. When I think about succession planning in a healthy balance sheet. I'm. Not an insurance person, but it's not the worst thing for me see cash surrender value life, insurance, in there which. Of course kicks in obviously. When. The ultimate, events occurs, but. These. That structures let me let me tell you all something I, get involved with banks as Mark does they're, not here to help you out in, and. When you lose your CEO, they're they're there to protect the interest, of their shareholders which. Means when critical. Events occur that, caught that make the death callable, they're going to call it. Right. And I, think, we've I think we've all seen it so. So we're going to segue from there into. Slide. That we put together called. Financing. Transaction. And. This may speak, a little bit to, some. Of the one question, that we had on. Transitions. From owners. To employees. And, the. First, bullet. Point on this slide may be a little bit confusing. Where, I came, up with this terminology, Bank, of founder, / owner and. The. The, reality behind that, bullet, point is many. Transitions. Many, piece many, succession. Plans. Involve. Seller. Financing. Seller, financing. Is what I refer to as as Bank, of founder. Because. When. Oftentimes. When you segue to the second bullet point here who, has invested. Capital so, we talked a little bit about the, idea of, you. Have the sale from the owner, of the business to the current employees, and the business, and, you look at those employees, and the employees, will tell you I'd, really like to buy a piece of the business I'd like you know I've been working here for the past 10 or 15 years I'd really like to buy a piece of this business I love this business how do I get into it and the, owner looks at them and says we'll, bring your checkbook yeah, bring, your checkbook and we can talk about how I get paid for my ownership and business and, oftentimes. You. Have this look on the employees, face that basically, says well I don't really, have a checkbook, and. It's. A it's a very common, situation in, today's world as you. Look, at the transition. Of businesses, from owners. Such as they are right now who, oftentimes, have, tons of sweat equity under, their business, have, bootstrap. The living daylights out, of it in, order to put themselves into, a position where, they've promoted a lot of value, and then, all of a sudden turn, around and try to sell it to their employees, and the employees, say I don't, have anything to invest in the business, which.
Turns Me back to is the, bank of the founder. And. Its seller financing. And. So, I think one of the things that you see and I'm sure dancing, this before is you have you, have many employees, who have time in their seat but no check oh yeah and I. Think that many. Business. Succession, plans, are, going. To be back stopped by, that seller financing. They're going to be back stopped, because. The, employer, or, whoever, the founder, is is going, to be in a position where they're going to have to finance a big chunk of the transaction. And they take on the risk obviously. That. It doesn't work right, and they're. Not in control all of a sudden so so in our world you sit back and you say well how do you mitigate that, greta how do you mitigate risk, and if you talked about some of the things if you want back to some of the things that we talked about from a management succession, perspective. Your, risk is that the employee is not successful. In, running the business as, you've transitioned, ownership. To them so. What, do you do to mitigate that risk you, get, them ready, to, run the company which. Is why. You say, you want to get them knowledgeable. About the business you want to get them into a position, where, they have developed, skill. Sets about critical, decision-making yeah I think, this, ties. Into part. Of our earlier discussions, as well mark oh. Well thought-out plan. There, isn't this bright yellow line you, didn't own any of it yesterday and, tomorrow you own all of it and you got to figure out how am I going to fund. This, overnight. Transition. If you will. That. That. Allowing. Employees, over time to, buy into the business, where where. The owner is, gradually. Reducing. The. Percentage of ownership in exchange, for liquidity, in the privately, held business, and. That can help if, you will and that is a more orderly, transition. But. The. Founder has to agree to it once again if they're very skittish, about, sharing. If you will the. Equity PI it, can be a difficult thing to convince them that it's a lot better to do it now while. Things are running smoothly and you're in control and you're vesting these up of these managers, and making them think like owners, as opposed. To let's, wait till the critical event occurs and all, of a sudden we're in a node or. A, room closing, the door trying to figure it out where, nobody has any money right, and that's oftentimes why you see what I refer to here is stage succession. Yeah and that is you. Know it is Dan said is there is not, a bright, line there, is not a bright line between what's. There now and what, the next generation is, and oftentimes. What, you will see is this element. Of you're. Going to get in for a first bite in ownership of the business the conversation. Between the founder, and the owner and the employees, is, I'm. Going to let you in I'm going to let you in the business I'm going to give you an opportunity to participate and, the, first piece of it will have a fairly good discount, on it yeah but, the last piece when. You're going to buy me out and I'm going to sail off into the sunset is, going to be a very expensive piece for you and, then make your original, piece worth more believe, it or not that's, exactly, right and and. I, think that, that's a hard thing to come to grips with because, many owners look at it and say well just go to the bank get some final yeah those are sitting there they'll. Take your house your car everything. You have is collateral and you. Know that's risky things with people, with families, and people, are dependent, upon them to tie to their. Future, economic, success into, one item. If you will right so it's. It, can be done orderly, and there are ways are, a creative. Ways like okay. Let's say your job calls, for a salary of 125,000. Then maybe you'll get a piece and you work for a hundred thousand, something, that. Ultimately. Rewards. The owner for. The risk they took to, bring this business to the point is that that's exactly right and it's really it's. You, know what we often see is that, in that, last piece, or what I refer, to as the the last piece that carries, the premium, it's, at that point in time that you have some ability to talk to the bank's about financing. Because the banks want to see that that next generation has. Some vested, ownership, they, have a vested tied to the business, and they, want, to see that they have some equity, and skin middle that they paid for and it reduces, the need for the bank at some level, right if we've already gone through some, transition. And cashed, out the principles, there. Is less need for the financing, right angle. So Lee and so so, it's only as as you your plan migrates, down the road from a succession perspective. That that, oftentimes, you really get to talk to the bank about financing. Or you get to talk about venture.
Alternative. Financing, and what. That speaks to is it says well, if you thought somebody was going to buy you out in five years from this business you, may be really, thinking about periods, that are 10 years and more for you to be able to be bought out of the business. That's. A hard as a hard leaf for founders, when they're young these. Are going well, but. Button. Modern. Master, and theories, of. Optimal. Behavior suggests, that, the, players in the game have a big stake in it and. Banks, want to see that yeah and. Your financing, wants, to see that that one they want to see equity, and in. The succession, plan if the, business owners, and founders, haven't. Set up the next generation, to. Be able to have some of that equity in the business where, they can talk about alternative. Financing, sources, the. Founders, actually have not done their job yeah they've not put they've, not put the next generation, into a position, that they can actually execute, on a buy of the company, they paced themselves, into a financial corner. And. You know the adoptions, then become, very limited right, so. So we're going to finish up with one last slide that I called, the hard topics. And. And some of the things that you have to reconcile, with is the. Owners view of valuation. Versus, the buyers view of evaluation. We. Right. Out of the blocks we talked about valuation. And. I think this is truly a case of beauty is in the eye of the beholder yeah, you. Know different valuation. Comes because. People see risk in a business differently, and if. You, look at, valuation. Theory that that, Dan has taught for four, decades and, probably, could, teach. Me a few more things that I actually know right now it's all about risk well it's all about educating, a high energy holder all right I know, my house is worth more than you think it's worth yeah, there's. A lot of buy low sell high. Statements. Out there but they're hard to come by right and, and, and, one of the things that that I challenge, business. Owners on all the time is to, to. Get an outside view of value in absolute. And and, absent. That you. Can fall in love with your own story you can breathe in your own ether and you. Can convince yourself that. Your. View of valuation. Is really right when in, the end the. Most important, view is the buyers view evaluation. Because they're the one who is going to actually pay. That. Valuation. The. Next little topic we talked about is the emotional, connection, to current, management and employees, I guess you could parenthetically. Say love the one you're with. I think. That, one of the big challenges that business owners have from, hard, topics, perspective. Is. Seeing. The people around you seeing. What their what, they've done for you in the past and sometimes. Having to make a hard decision that, they're not next and. And, they're not a part of the future and, just. Because they're there you develop, this emotional. Connection of them yeah you know, everybody. Can't be next everybody. Can't be part of the next step but. There are other ways to satisfy your, emotional. Attachment. To key, people who have helped you get to where you are. And. So you have to think. About it that way that's why the. Privately, held more that I referred to earlier, where the owner said look I can't deal with selling, this place I can't, deal with these people who have gotten in here losing their job and the adviser said then step out of it get out of the way we'll. Do it for you because otherwise. You're going to die with this business your state's going to get nothing it. Just it, just can't, you can't have everything here, so, if. You want to take care of people, who've been important, to you we're, going to get this business sold. You're going to get a bunch of money and then you can do what you want with it and that's. And that is that. Is that emotional, connection that. Disconnected. You from what's important, and that, was to, produce value, absolutely, if it turned out to be highly. Emotional, every time this owner would get an inquiry he'd, get the inquire my name and. I'm like why. Don't you take care of it I can't I can't all right well right, we, respect, that and we're going forward, right, so. So that that really segues, into you. Know how do you implement, change. In. Leadership from, the founder, I I've.
Heard. It, more. Times of more fingers and then I have fingers and toes I've, heard, it that I'm, the CEO I need to be here I'm the founder I'm the I'm the guy who has built this I'm, the, the woman who has determined. This direction, I am. Next. And the, challenge, that we gave to people up front is really. You, might not be next and you. May well be in a position that you need to, spend. Some time to hand your baby off to, the next generation, and do, it in a way that, is. Thoughtful. And not, like. A mic drop so to speak. The. Other big hard, topic, I think that that many small, and medium-sized business owners have, challenges, with his family. As the next leaders I, have. Seen, situations where. Family. As the next leaders has, been the best decision on, the face of the earth and I've also seen situations where, family, as the next leaders could, not have been a worse decision. And there. Are some. Very. Very difficult topics. That people have to think about when, they think about having a conversation where, they go to their child who. May be you. Know 30 plus years old and say I really don't think you can run this business going, forward I don't think you have the skill set and to. Help me help you I'm. Actually going to have somebody else run our business yeah. There's, the last last. Couple points, I think, are, real, big realities, coming, to grips with the leaders mortality. And relevancy. Mortality. Obviously, it is a gigantic. Issue from, a succession, perspective. It doesn't need much more explanation, if the leaders not around, anymore. And they're not there to promote succession. The. The thing that always scares, me, the, most from both my own business, perspective, as well as as people, that I work. With, better. Clients, and friends, is. Your, relevancy, can't. Can you maintain a. Skill set can you, maintain thought. Processes. Can you maintain. Forward-looking. Thoughts, that allow, you to continue, be relevant, in. The world that have thoughts that are that. Are important, to running the business. And. The last topic I think is always, the big topic, is. Do, you have enough runway and it's. I guess it's an aviation, analogy, and basically, they have enough runway that, the planes not going to run off the end of the runway and crash into the woods yeah. And, the answer to that is we never quite know precisely. How. Much runway we have we. Can look at the actuarial. Tables but, we're pretty individual, so though. Some people go on and on and on effectively. And other times there's random, factors, that. That. We don't control that force us to make. Decisions like who's next and. And. And, that that is probably, one of the hardest questions that. You'll have to answer in.
The Hot topics, category, and I like, to assume not, a lot and. I, think I think that's good as social not a lot of runway why don't we plan as if, you. Know the truck, could hit somebody tomorrow, we, don't get implemented, by any means and it should be an executive, session, or. Privately. Discussed. With owners and their advisers so. That it doesn't. Cause, all of a sudden this. Discussion. In, closed doors and dark corners, like this, company's going under or being sold or whatever, impairs. The. Ability of all. Those employees to operate, at their highest level right. I. Think. We're at the end and I. Really. I, really hope that everybody that listened in or will be listening, and I've. Got a couple nuggets to take away today with. With. Dan you've got a world of, experience. And with. Marc you've got a world as experienced and applied. Applied. Examples. We're. Lucky to have you come in, and. Talk to the alums so thank, you yeah thanks, for having me yes thank you both very much you, where we are both you. Were both. Wonderful people to have speaking on this topic it was a masterclass if people, don't realize.