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PASSING THELEADERSHIPBATON Avoid the

Gold Watch Retirement Gift

By Samantha Park

L et’s begin by establishing “passing the leadership baton” as a bit of a misnomer, it’s more like a bomb that could completely disintegrate everything you have worked so hard for over the past thirty-five years if handled

poorly. You know, the kind of crudely made bomb you see in movies that use a fancy gold-plated watch as the countdown timer that turns out to be the ‘bombers’ retirement present (1994 classic Speed, anyone?). But hey, this is the alarm business and if there is one thing we know, it’s our way around some colorful wires. Passing the leadership baton is a term commonly used to describe a pivotal moment, which you’ll find out can actually take years, of transitioning a business to the next generation. While ‘generation’ can be literal, as in S.C. Johnson and their impressive five-generation span of ownership, it can also be figurative such as new leadership from an outside buyer or succession that involves a longtime, trusted employee. If you’re thinking, “I’m not retiring or selling for another five to ten years, I don’t need to worry about this yet,” you are exactly who needs to start preparing now.

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When considering 90 percent of businesses in the United States are family-owned or operated, combined with the large scope of the baby boomer generation that is solidly within their retiring years, the process of passing the leadership baton is likely to hit the majority of American businesses over the next 10-15 years. Succession planning should be top of mind for ESA members regardless of the life cycle stage of your business. The electronic security and life safety industry, which is overwhelmingly comprised of family-owned or operated organizations, will be facing this typically once-in-a-lifetime event very soon. Our industry represents the very backbone of the American economic engine, and we are about to find out the trade-in value. No pressure.

Sell, Sell, Sell If multiple experts told you the same thing, you would listen, right? The Electronic Security Association caught up with ESX “Passing the Leadership Baton” session panelist Jeremy Bates, president of Bates Security, session moderator Robert Few, director of Charter Communications IntelligentHome, and John Colehower, principal of Mergers & Acquisitions L.L.C, a consulting firm that specializes in the electronic security industry; and they each advised the same ‘best practice.’ No matter the situation, set your business up for sale. Few explains, “Whether you are selling, transitioning to the next generation, or handing over to your star employee, you need to start in the same place and that is getting the business in order.” A common misconception that can occur in traditional alarm companies is treating the transition as an overly informal or negligible process than if the party acquiring the business was an outsider buyer. In a familial succession, it can be easy to forgo the formalities, adjust the nameplate on the president’s office door to read ‘Jr.’ and call it a day. “First and foremost, you want to make sure your business is intact, running smoothly, and that you can report out on everything.” This begins with proper accounting and full transparency into what money is coming in and going out, including contracts, and the bread and butter for alarm businesses, your RMR. This step substantiates your valuation; it is a price that is figuratively priceless.

Depending on the size of your business and the structure of your sale, an outside accountant reviewing your books may be a wise decision. Colehower clarifies, “For small, tuck-in acquisitions where the buyer is simply purchasing alarm monitoring accounts and little else, the seller’s accounting (other than being able to prove the RMR it collects) may not matter to a buyer. However, when the seller is looking to obtain value for its service revenues, it will need to be able to demonstrate the profits that it makes from that portion of its business, and more detailed accounting will be required. For sales of an entire business, where the buyer is taking over the seller’s operations, office locations, employees and vehicles, the buyer will require detailed accounting records over multiple years. In those situations, reviewed and/or audited financial reports will certainly lend confidence and result in a greater sale price. As a business scales up in

size, it needs to move from QuickBooks to mainstream industry software in order to generate reports for management, lenders and potential buyers.” Taxes for the sale of a company are a headache, actually all taxes will make you reach for the extra-strength Excedrin®, but they make the world go ‘round so they are an important aspect of succession planning. Generally speaking, the check you cut to Uncle Sam differs depending on your corporation status. An ‘S’ corporation is an entity that, through a special IRS tax election, minimizes taxes in asset sales. This can also be said for LLC’s or sole proprietorships. ‘S’ corporations defer to their shareholders when it comes to “corporate income, losses, deductions, and credits” according to the Internal Revenue Service (IRS), “shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates.” While there are stipulations to qualify for this business structure, the advantage is singular taxation. During a ‘C’ corporation sale, taxation occurs at two levels, corporate and individual. “For any ‘C’ corporation owners who are considering a sale of their business, it is strongly suggested they consult with their accountants about changing their ‘C’ status to an ‘S’ election. It can take years to accomplish this, so the sooner you start, the better. A method commonly used to avoid double taxation is a sale of the company’s stock instead of assets, but buyers have additional liability and tax issues to contend with,” says Colehower.

Surround Yourself with the Right PeopleUnless you happen to be a mergers and acquisitions professional, selling a business is something few have done before. Entrepreneurs like small business owners may be tempted to take a crack at it themselves but having a team of professionals on your side is a best practice that, if ignored, can cost you. The ideal team will consist of an attorney, accountant, and business consultant, preferably who each specialize in the electronic security industry. In Colehower’s vast experience, “Good industry professionals add a great deal of value to a seller in helping them negotiate the terms, maximize the price, find a compatible buyer, and protect them from hidden adjustments and veiled contract provisions… the business consultant conducts an initial due diligence to get the company ready for sale, markets the company in a professional manner, and negotiates the business terms. The attorney reviews and advises on the buyer’s purchase documents and the accountant structures the transaction to achieve the

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best tax result. In the final analysis, most sellers have spent years building up their business and only get one opportunity to cash out, so they should do so with a professional team.” A common misconception is that running a successful business equates to selling one. “Without the assistance of an objective third party, you don’t know what you don’t know. It would be like having a lawyer install an alarm system…, we all have our own skill sets,” says Colehower.

With a team of talented professionals behind you, it’s time to look to the future and that is your successor and their preparation. Bates Security is doing just that with their current generational transitions from mother and father to sons. “In our case, our parents plan started with making sure that my brother and I learned the company from the ground up. Between the two of us, we have worked in every entry-level position in the company and were never given any preferential treatment. We had to earn our way just like anyone else and had to demonstrate we had the work ethic, desire, and ability to learn and grow with the company. In short, we had to prove ourselves as we went along and accordingly were given more and more responsibility to where now we are running the company with little involvement from our parents. We are all working hard to grow our businesses, this valuable asset, and if a plan is not put into place to buy the current owners out or put in place some type of estate planning, then an untimely death can jeopardize the business. Involve expert attorneys and financial planners to develop a plan that works for your family which is what we did. This area is the part that is easy to put off, which is a critical mistake,” explains Bates. As with many family businesses, structured long-term payouts and estate planning come into play and it is vital to note that a ‘handshake’ agreement is not valid or wise. The family aspect adds personal dynamics that can take misunderstandings straight to a courtroom.

A Lack of Communication is Costly, How Much Can You Afford? Communication or lack thereof, is directly indicative of your businesses sustainability. It’s a fairly simple concept that is underestimated but easily rectified. In terms of the most valuable asset in your business, which is your people, a best practice is to exercise communication early and often with an objective of appropriate transparency. Communicating with your chosen successor can avoid situations of unanticipated disinterest or top talent defecting to competitors. At this level of the business game, your competition knows the players. If you have been grooming a replacement for 15 years, teaching them the ins and outs of your business, without communicating the end goal of them taking over, you run the risk of them slipping away to another organization; to a company that was clear in their desire to have your protégée run their business when you failed to do so. That’s 15 years of work you won’t recoup any revenue on. Worse yet, may be assuming the next generation of your family wants to continue your business when they actually want to venture out and do their own thing. Less than 50 percent of family businesses survive into the second

generation followed by only 15 percent surviving into the third generation. This supposition can leave you with a team full of disgruntled employees who were passed over for the son who doesn’t even want the company, tense family dinners because the nephew that did want it left to work for your competitor, and a passport you can’t seem to fill with stamps because you are on speed dial with the office you were trying to get away from.

Costly doesn’t begin to describe this nightmare. Making sure everyone is well-informed instills a sense of loyalty among employees and reassures investors, supporting leadership, shareholders, and family that the succession plan is effective and on track. Family or not, assessing if you have the right person to take over your business centers around one trait; passion. Few explains, “You need passion. Forcing passion on the next generation, where passion isn’t there, will lead to a failed business. In running an electronic security company, you’ve got to

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be passionate about helping people. You’ve got to be passionate about taking care of your customers and growing your business; without these three things you’re not going to be able to run an effective and customer-centric business.” A talented accountant, a dynamic sales team, a results-oriented marketer are all hirable but passion is an innate characteristic that cannot be taught. If your successor has this, your baton will safely rest in their hands.

Passing the leadership baton to the next generation, family or not, is a test of your skills as a leader, businessperson, and individual. It will challenge your resolve but also serve as your legacy and reward for a lifetime of hard work. Just remember, start planning early, set your business up for sale regardless of the acquiring party, surround yourself with the right people, and communicate early and often to ensure your business can sustain for generations to come. Rather than a gold watch to commemorate a successful ‘passing of the leadership baton’ and retirement, opt for a seven-day cruise.

“COMMUNICATION OR LACK THEREOF,

IS DIRECTLY INDICATIVE OF

YOUR BUSINESSES SUSTAINABILITY

”