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Facilitating an Internal Transition

Carla McCabe
Feb 1, 2021

For many owners, an internal transition to the next generation is the preferred method to plan for succession. It’s particularly attractive because the transition can be gradually done over time, it allows owners to mentor and groom their successors, the owner(s) can retain control while transitioning, and it eases many of the emotional obstacles for owner(s).

But the entire process, when taken as a whole, can often feel overwhelming or daunting. Owners are left wondering how to implement the plan they have in their mind and may be concerned that they’re forgetting some critical aspect. While you should always work with a professional to design and implement your internal succession strategy, the following checklist will serve as a guideline to help you get started.

Review firm structure – If you don’t currently have a legal corporate entity in place for your business (i.e., S Corp, C Corp, LLC, etc.) and are instead operating as a sole proprietorship, you’ll need to set one up. Now is also a good time to review your current structure to make sure it will best facilitate your transition goals. There are pros and cons to each type of corporate structure, especially when it comes to equity distributions, so be sure to consult with a professional.

Consider a recapitalization of the firm – Oftentimes, we see firms that have been set up with very few shares (e.g., 100) of which, all are voting. This can be problematic when it comes time to start transitioning equity. As a general rule of thumb, it’s a good idea to have your voting shares only represent 10% of the total equity. This allows an owner to monetize and transition 90% of the equity without ever giving up control. You’ll likely also want to expand that equity pool (to say, at least 100,000) so you have enough shares to work with, especially if your goal is to transfer equity to multiple individuals.

Finalize valuation & determine buy-in price – Now is the time to review and update your firm’s valuation. You’ll then need to use that valuation to determine a buy-in price. You may decide to give your next gen a “leg up” and use a price that’s lower than your valuation. There is no right or wrong here; you must decide what you’re willing to sell equity for and your buyers must determine what they’re willing to pay for it.

Draft transition timeline & financial modeling – There are many timeline options when it comes to transitioning equity. Some owners will sell 10% a year over several years. Others may transition 40% up front and then not transition any more for a few years. Start modeling what this may look like from an ownership and distribution standpoint. Also take into consideration how the buy-in will be financed and incorporate that into your models. Many owners will do no down payment with each tranche of ownership financed over a period of time (via a seller note) – see how that translates for your buyers. In other words, will the equity distribution make it affordable to cover their note and interest payment each year?

Create transition documents – You’ll need formal documents to sell/transition equity. Be sure to work with a professional to draft an Equity Interest Purchase Agreement and any related notes if the sale is being seller financed. Once drafted, you should be able to use these for all future transitions.

Review or create corporate operating documents – Now that the firm’s ownership is going to lay in the hands of more than one individual, it’s time to review and revise (or create) operating documents that outline exactly how things should be done going forward. This document (either an Operating Agreement or Shareholder’s Agreement, depending on your corporate structure) will set the rules for item such as: ownership transfers upon death, disability, and retirement (for all equity owners) and the transfer rights, firm dissolution, forfeiture of ownership, and puts and calls, among other items. While these conversations may be difficult to navigate emotionally, it’s important to create guidelines now for how you want any possible “what if” scenario to be handled. And remember - these guidelines will not only apply to the transition at hand, but for every future generation of owners.

Review or create employment agreements – With multiple owners, it becomes even more important to make sure that everyone has an employment agreement to outline roles and responsibilities, and how they will be compensated. Employment agreements should also contain non-compete, non-solicit, and non-acceptance clauses. Keep in mind, both employment agreements and operating agreements serve to protect the firm and not any individual employee or owner.

Consider the use of an advisory board/board of directors – This optional planning may come in handy if your slated next gen isn’t quite ready for ownership yet or if you have children who may someday enter the business. It can also serve as a Plan B if something goes horribly off the rails and your intended plan doesn’t come to fruition (e.g., your next gen becomes incapacitated).

Consider developing a partner progression plan – As you think about how your firm will transition going forward, it might be beneficial to outline how individuals can work toward ownership. This progression model (think similarly to how a law firm advances partners) takes the guesswork out of any necessary requirements for your key employees. Set clear milestones that individuals must meet in order to be considered for equity ownership.

When broken down into manageable pieces, your planning becomes more process-driven, rather than a haphazard hodge-podge of ideas. Most importantly, remember that this type of corporate planning isn’t just to transfer your equity to that of your successor – you’re laying the path for ALL future transitions and how you want the firm to operate for generations to come. Don’t make the mistake of not thoroughly thinking things through, potentially forcing future generations to have to retrofit solutions to fix poor or incomplete planning.


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