SUCCESSION PLANNING

AUGUST 2016

Structured process involving identification of a potential successor

to assume a new role

Definition Ensures Provides Helps Event or Process

Smooth transition of business from one generation to the

other

Peace of mind by making sure that all

stakeholders are taken care of

In avoiding conflicts and legal battles after

you are not there anymore

To ensure that your legacy outlives you, it should not be limited to an event, but

should be a process

Succession Planning – What Is It?

Stakeholders In Succession Planning

Three categories of stakeholders– Family members, Owners of the business, and Managers/Employees Each stakeholder has hopes and expectations Succession Planning could thus raise conflict of interests among people involved A formal process can quell some of these conflicts – everyone feels assured that their concerns will be heard

Family

Business Owners

Employees and Managers

While this group has less power toinfluence how the Succession Planis organized, it is also dependent onthe continued viability of thebusiness. For this group, aSuccession Plan should inspireconfidence that the businessremains a going concern while theleadership transition takes place.

Successors may not be interested orable to take over active ownership ofbusiness. Succession Planning shouldtherefore include how the business willbe transferred to the next generation orhow ownership will be cashed out andmoney used to support family.

Even if you are the primary owner,any minority owners also need tobe included in Succession Planning.For example, in the event of yourretirement, the BOD will have a sayin who gets named to run thecompany when you step down,even if your ownership portiongives you control over the Board.

Principles for Succeeding in Succession Planning

1

2

3

4

Start Early

Set Expectations, Philosophy and Values Upfront

Understand Individual and Collective aspirations

Assess what’s right for Business

5

6

7

8

Develop the Successor’s Capabilities broadly

Develop a clear Selection Process

Find ways to balance business needs and family aspirations

Build credibility through a phased transition

Principles for Succeeding in Succession Planning

9

10

Ask departing leaders to leave but not disappear

Motivate the best employees and foster their support

Principles for Succeeding in Succession Planning

Succession Planning Process

Others’ Goals

Owner’s Goals

Management Needs

Best case Scenario

Explore Options Implement

Business Owners should identifypersonal goals for their futureannual income, their level ofinvolvement in business, theirinvestments both inside andoutside of business, their legacyfor the future and their values

Important to identify the needs,goals and expectations of familymembers, other owners and keyemployees. Consideration oftheir expectations ensures thatgoals can be met.

To ensure business continuation,it is important for businessowners to identify who is capableand willing to take on his or herresponsibilities. This may includenew compensation structures asan incentive to key managers.

Based on Business Owner’svalues, he or she must balancethe needs and goals of everyoneinvolved. The resulting plan is“Best Case Scenario”. This is themost optimum situation in anyBusiness Succession Plan..

Unfortunately, this step is skippedby many business owners.Business owner needs to exploreall options. This often means thatafter they have designed the plan,a new and more efficient solutionemerges, leading to expensivechanges midstream

The final step is designing andimplementing the Succession Plan.Professional advisors who designthe plan also help devise a processto implement it. A timeline for thesame makes intentions clear whilemanaging expectations

1

Decision-making

ability of Successor

6

Financial skills of

Successor

2

Successor’s

commitment to the

business

7

Strategic planning

skills of Successor

3

Inter-personal skills of

the Successor

8

Relevance of

Successor’s prior work

experience

Successor’s respect of

Employees

4

9

Successor’s current

ownership percentage

Best person for the

job regardless of

family ties

5

10

Active role in strategic

decision making

(Advisory Boards)

Factors in Succession Planning

Strategies and Tools in Succession Planning

1 : Valuation

3 : Sale to an outsider

2 : Keeping it in the family

4 : Liquidation of the Company

Most important tool while looking to transition outthe business is to determine what it is really worthin the market. That means getting a thoroughvaluation done by professionals. Often, owners findthis as an unnecessary waste of money, as theybelieve that they already know the business’ value.Unfortunately, this might not necessarily be theactual value in the market.

Selling business to outsiders is traditionally notconsidered as “Succession Planning”. However, forsome business owners, it may be the best way tomeet their expectations for their retirementincome. Steps here involve “Cleaning up” thebusiness to make it attractive, bringing in an advisorfor sale, putting the business on the market andadvisor responding to interested buyers,negotiating with buyer, finally closing the deal.

Majority of business owners want to continuefamily ownership of business. Unfortunately,70% of businesses do not survive secondgeneration. For a good Succession Plan, toolsinclude gifting stock (which is most widely used),forming a Trust (which can help reduceTaxation), or selling to a family member (whichmay, in effect, maximize taxation).

Liquidation does not strictly fir into “SuccessionPlanning”, as there isn’t much “succession”when a company ceases to exist. In some caseshowever, liquidation in fact is the best option forthe business owner. With liquidation value beingMarket Value of assets less liabilities, theprocess involves appraisal of value of companyassets, and calculation of liabilities. LiquidationValue is generally lower than Market Value.

1. RiskThe longer owners wait to design and implement a succession plan, the greater the risk that the plan will not meet goals, and that business will go down along with health of owner.

2. OptionsThe more it is delayed, the fewer options owners have to meet goals of providing continued income for family members and establishing a personal legacy

3. ControlThrough succession planning, business owners ensure control retention, which would have otherwise gone into the hands of lenders or attorneys.

4. ValueDelayed or no Succession Planning can cause significant drop in the value of business. Intended beneficiaries in such cases, do not receive full value of business had a succession plan been in place.

Why Think Of It Now

When it comes to Succession Planning, one of the biggest traps to avoid is “waiting too long” It is emotionally difficult to choose between a close relative or an employee It takes years to train a potential successor and make them capable enough to take charge of the business Finding the right advisors also significantly determines the success or failure of Succession Plan – Lawyer, CA, Valuation Expert and

Tax Experts

Unplanned Transitions Destroy Value

For many family-owned businesses, Succession Planning is the proverbial ‘Elephant in the room’. Despite recognising the importance of selecting and preparing a successor, the leaders of a family often do not give Succession

Planning the attention it deserves. According to a survey by The Boston Consulting Group (BCG), family business leaders ranked succession as the second-most

important subject on their minds, topped only by the closely related issue of achieving alignment among family members on critical topics.

Despite this, more than 40% of family businesses have not adequately prepared for succession.

Source: BCG Analysis of more than 200 transitions that occurred from 1994 through 2014

-2%

17%

0.5%

-16%

-11%

-3.9%

Planned Transitions vs Unplanned Transitions

Planned transition Unplanned Transition

Growth Market Cap EBITDA MarginRelative performance of

revenue CAGRRelative change in Market

Cap CAGRRelative change in EBITDA

Margin

-14 percentage points -28 percentage points -4.4 percentage points

Problems Faced in Succession Planning

Source: The Family Business Map – authored by Professors at INSEAD and Chinese University, Hong Kong

While leaders may have a clear vision for the

business in his mind, he often fails to

communicate it to the rest of the employees, or

even his family members

Lack of communication

Second generation is often unable to create value in the firm. This

generation should be able to tap into the strengths and family

assets that the older generation has been able to create

Second generation

Business tycoons and bosses generally continue to lead their

businesses, even in their 70s and 80s, and they never retire because

they never plan so. Family management is not properly governed,

and roles and responsibilities of family members not defined

No retirement plans

As per a study by INSEAD Professors of the Asian Markets over a ten year period, it was found that family businesses lost almost half of their value or wealth as they underwent transition

Things to be kept in Mind

01

02

03

04

Search for right AdvisorAdvisors may collaborate with other professionals including Lawyers, CAs, and Valuer, who would help in tackling estate planning issues, tax related concerns, and money management considerations in success planning. There is no checklist or flowchart involved. A lot depends on persons involved, shape of their records and their mindset.

Discuss and revisit PlansIt is important to remember that a battle plan is

obsolete as soon as the first bullet is fired. The Succession Plan must be dynamic enough to adjust for any changes, because tax laws and

other regulations may change. Also, there might be need for course corrections as a result of

things that are out of control.

Evaluate own retirement savingsImportant for owners to consider whether they have sufficient

retirement savings and insurance. Succession Planning is however, not synonymous with buying insurance and other products. Using

risk-reduction products can be a smart move, though certainly not the only consideration.

Don’t wait too long to beginIt can take as long as a year to put together a Succession Plan, to be implemented over the course of many years. As per Kahler Financial Group, it is advisable for owners to start the succession planning process as early as 10 years before their anticipated retirement date. To reiterate, one of the biggest traps to avoid is “waiting too long”.

Case Study of Tata Sons

A 5-member Selection Committee established in 2010, with members from Tata Trust and Tata Sons

The committee held 18 meetings in 15 months

Interviewed large number of candidates

Mistry family being the single largest shareholder of Tata Sons (18%) not a factor in selection of Mr. Mistry as the

Chairman of Board

Once selected, there was a year long transition where Mr. Mistry worked directly under Mr. Ratan Tata to get ready for

the top job

Some of the guidelines for identifying the successor of Mr. Ratan Tata:

• Long run way – Leadership continuity for next 25 years

• Tata Group Ethos

• Experienced in handling similar size, scale, scope, complexity and diversified portfolio

• Shareholders/stakeholders acceptance

Case study of Emami

Kolkata based Conglomerate – have set up a Family Advisory Board

Intent - to make the younger generations of two unrelated families of RS Agarwals and RS Goenkas to participate in

family business.

US Based The Family Business Consulting Group hired for its professional assistance in this process.

Positive impact : No different voices in the family and they are similar in nature though comes from two different

families.

Younger generation trained to have a unified approach while working with the non-family professionals to make the

operations smooth. A major step towards creating a coordinated structure/team of hired professionals and equally

capable family youngsters.

To ensure unanimity and achievement of business goals, formal business code of conduct has been laid down for the

second generation. The code contains an exhaustive list of do’s and don’ts.

Family Businesses in India

Family companies account for two-thirds of India’s GDP 27% of overall employment (79% of organized private sector) is generated by family owned businesses Most of the big corporate houses including Tata’s, Ambani’s, Birla’s, Vedanta, Bajaj, Ruia’s, Ranbaxy, Bennett Coleman and Company

and many more are all controlled by families Brand of family names, family reputation and goodwill, elements of self-discipline and self-governance are some of the factors that

help family firms in India survive for generations Inter-family disputes, patriarch acting as a control freak, lack of professional management, lack of written agreements to address

any conflict, lack of communication amongst family members and inability to keep pace with modern techniques and advancements are key challenges for Indian family firms

Successful transition from first to second

generation

of family businesses survive to third

generation

of family businesses survive to fourth

generation

30% 13% 4%

Source: Sparrow Advisory research

Succession Planning Matrix

Owner Motivation & Perspective

Personal financial planning

Business structuring

Business Performance

Strategic Planning

Leadership Mgt. and Continuity

Mgt. Synergy and Team Work

Successor Preparation

Family Dynamics

Family Governance

Succession Matrix

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