Business Succession Planning IRTBA Presentation February 14, 2012 William J. Cotter Coman & Anderson, P.C. 650 Warrenville Road, Suite 500 Lisle, Illinois

Business Succession Planning – Our D iscussion Items: Part 1:Why Planning is Important – The “Business Case” Part 2:The Challenges in Developing Effective Plans … and the Benefits Part 3: Leadership / Management Succession Part 4: Ownership Succession Part 5: Starting the Process Early 2

A Note on Terminology...  Succession planning  Strategic transitioning  Succession strategies  Exit planning  Ownership succession  Exit strategy planning  Transferring ownership 3

4 A Note on Terminology...  Succession planning  Strategic transitioning  Succession strategies  Exit planning  Ownership succession  Exit strategy planning  Transferring ownership “Succession planning” is the process of preparing to transfer control AND ownership of the business to others in a way that is the least disruptive to the business’s operations and value.

Part 1: 5

First Some Numbers studies forecast that within the next 10 to 12 years, there will be a dramatic increase in the number of business owners looking to exit their businesses. And: o 63% of business owners are baby boomers o 40% of owners plan to exit within the next 5 to 7 years o 80% plan to exit within 10 years 6

7 An Important Challenge: It’s also forecast that there will be more sellers than buyers.

A majority of companies are not saleable today for what the owner expects - as a result of any number of fundamental flaws valuable – such as a large concentration of clients or customers, or a lack of quality leadership in the “business pipeline” to take over. 8 An Important Challenge: It’s also forecast that there will be more sellers than buyers.

Implications of business supply exceeding business demand:  Possible reduction in the value of company  Increased likelihood of turnover of key employees  Potential business closure  Diminished availability of exit options 9

Part 2: 10

What percentage of privately held business owners have prepared a business succession plan? 11

What percentage of privately held business owners have prepared a business succession plan? 12

The Challenges to successful development and execution of a succession/exit plan: The Challenges to successful development and execution of a succession/exit plan:  Over-dependency on existing owner(s)  Conflicting visions of key employees (or key family members, if a family business)  Lack of accurate professional advice - knowledge gap  A misunderstanding of the company’s true value  Shortage of suitable buyer(s) or other successor(s)  Availability to secure financing by buyer(s) or other successor(s) 13

So... why haven’t more business owners developed a formal succession/exit plan?  It’s much easier to maintain the status quo  It’s hard to deal with family/employee issues  The process seems too complex and too time consuming; where to begin?  The psychology of the planning process: is this “the end”?  The owners have embraced one exit strategy and are not interested in considering another (all the eggs in one basket) 14

15 What motivates the business owner to exit?

16 What motivates the business owner to exit? Half the time: External Factors  Death  Disability  Divorce  Other “Distress”

17 Half the time: External Factors  Death  Disability  Divorce  Other “Distress” What motivates the business owner to exit or sell? Half the time: Internal Factors  Loss of key employees  Loss of key clients  Loss of personal motivation (burnout)  They’re just ready to retire

What motivates the business owner to exit? Half the time: External Factors  Death  Disability  Divorce  Other “Distress” Half the time: Internal Factors  Loss of key employees  Loss of key clients  Loss of personal motivation (burnout)  They’re just ready to retire 18

The Benefits of a formal succession/exit plan: Reduces uncertainty and turnover of key management Helps key managers make decisions that are aligned with ownership goals Increases the value of a business Pleases bankers/bonding companies Gives business owners peace of mind May help minimize income and estate taxes Directs how and when owners exit 19

Part 3: 20

Leadership transition planning... Succession Management is not replacement management Leadership succession is making provisions for the development, replacement and strategic application of key people over time. It requires the identification of the company’s values, mission, and strategic plans. 21

Leadership transition planning... In the family business setting, leadership succession often includes: o Establishing a formal policy regarding family participation in the business. o Providing solid work experience for all employees, to ensure that succession is based on performance rather than heredity. o Creating a family mission statement based on the members' beliefs and goals for the business o Developing a strategic plan for the business. o Designing a leadership development plan based on the agreed strategic plan o Identify the tasks and the required skill sets o Identify prospective successors. o Identifying a successor –- or establish the selection process. o Setting up a succession transition team to nurture the successor. 22

23 Ownership Succession Part 4:

The Basic Models: 24 Transfer Models InsidersOutsiders SaleYES GiftYESNO Ownership Succession

Business Succession Options... Transitions to “Insiders” o Transfer or sale to family members (if a family business) For “full price”... or less? Gifting – in trust or not [Note: expiring gift tax exemption?] Sales to intentionally defective grantor trusts o Sell to key employees / management buyout Don’t forget the buy-sell agreement! o Employee Stock Ownership Plan (ESOP) o Owner cash-out vs. continued participation: Become an owner-investor (debt) Recapitalize the business (preferred stock) o Many variations on these themes 25

26 Business Succession Options... Transitions to “Outsiders” o Sale to outsiders (strategic or financial buyer) o Merger / Consolidation o Partial sale to private equity firm o Liquidate the company o Going public o Combination of some of the above alternatives

Evaluating Succession Options... Evaluating Succession Options...  Where do you maximize value – an external or internal sale?  The owner’s net worth outside the business  Business and industry growth prospects  Ownership dependency  Interest in business continuity of the next generation or of top management  The owner’s commitments to, and trust in, key people  Is the owner committed to establishing a “legacy”?  What’s the owner’s vision of their lives after the business?  Owner’s view and attitude toward risk 27

Part 5: 28

How do you minimize risks posed by ownership and leadership succession? Create a clear vision for the future that may include different ownership exit strategies Begin developing ownership and management succession plans 5 to 10 years before change in leadership or management is contemplated Plan for the retention of key people with common legal tools such as:  Employment Agreement or Change of Control Agreement that provides severance, outplacement for key people  Long-term incentives that align with interests of ownership, i.e. restricted stock, phantom stock, sales incentives, SARs or performance unit plans  Stay bonuses or incentives in certain transition situations  Skills development and education for employees  Inclusion of key people in long-term plans and information sharing 29

How do you minimize risks posed by ownership and leadership succession? How do you minimize risks posed by ownership and leadership succession? Protect the value of the company with: o Confidentiality Agreements that protect confidential information, intellectual property, solicitation of key employees, solicitation of customers, and narrowly-defined non-competes o Key-man life and disability insurance on key people, not just owners o Consider comprehensive medical physicals for key people o Up-to-date estate planning for owners to avoid ownership struggles o Educate your executors/trustees on your goals and expectations 30

How do you minimize risks posed by ownership succession? Develop future managers and leaders through: o Coaching and mentoring o Management and leadership assessments o Compensation plans for performance Implement a governance structure: o Consider a formal Board of Directors or an Advisory Board at least 5 to 10 years before a transition 31

Who Can Help with the Plannng Process? o Your Banker (wealth management, investment bank services, trust department, purchaser financing) o Attorney o Insurance Agent o Business valuation expert o Business broker or investment banker o M&A specialist o Estate tax specialist o ESOP consultant o Certified public accountant IT’S A TEAM EFFORT! 32

The Key Components: 33 Personal Personal goals for owner(s) Estate planning considerations Personal tax planning Wealth management Family business matters (in family businesses) Governance Advisory board Formal board of directors Family business advisory council (in family businesses) Management Succession and HR Matters Leadership/management development Leadership selection Executive compensation Family compensation (in family businesses) Risk Management Key man life insurance and disability Executive employment agreements Building wealth outside the business

Questions? 34

Thank You! 35