Succession Planning

Author: Larry Chester, President

Forbes reported that 90 percent of family-owned businesses fail in the third generation. It might be worthwhile to examine one such case of a lack of succession planning and see what happened.

Bringing Value Through CFO Insights

When companies fail it is frequently a combination of factors. But mostly, it’s just lack of preparation.

• Business – Machine shop – heavy equipment repair
• Work – Long-term (six months to a year) repair and reconstruction projects
• Sales – $9,700,000
• Ownership – Single owner, second generation, passing it to his son

Initial Contact –

The bank was concerned about the business’ cash flow. The company had used its entire credit line and regularly wrote checks that exceeded its credit line availability.

Significant Findings and Recommendations:

Profitability

When a company is short on cash, the first place to look is at profitability, not just overall, but at the unit level. What is the profitability of each product family, even each product that is sold, or each project that’s completed?

Recommendations:

• Do a detailed cost analysis of every completed project to determine if the actual cost of the project, and profitability, matched the estimate. Understand why the profit goal was not met. Use that finding to re-evaluate and manage current projects.
• Be more realistic when doing future estimates, being especially careful about labor estimates.
• Initial analysis showed that the biggest overrun of project expense was the labor component. Provide tighter supervision of line employees, so that they know the time expectations and their part of the cost of the project they were involved in.

Cash Management

The company regularly wrote checks without regard to the amount of money that was in their account, overdrawing their account regularly. This angered the bank and gave them little confidence in the company’s management.

Recommendations

• Create a cash flow forecast to project how much money they would have in each of the coming weeks.
• Issue a cash requirement report weekly to show the amount of money needed for payables, and only cut checks if there is sufficient money in the bank.
• Reduce the amount of unnecessary expenditures for software, office supplies, and miscellaneous items. Small expenditures add up.

Quoting New Business

The son was interested in growing the business significantly. Being ambitious, he started quoting jobs with estimates between $10 million and $15 million, well in excess of the company’s annual revenue of $9.7 million. Despite the company’s technical expertise, it was impossible to show prospects that the company could complete projects of that scope. Preparing these estimates and pricing them took significant engineering staff time and yielded no business after a year of trying.

Recommendations:

• Stick to what you know and do well. This might involve slower, but stable and consistent growth. The facility and staff weren’t sufficient to handle the bigger jobs, and the company didn’t win any of the new business, in spite of the effort put forth. The bread-and-butter jobs that were the company’s mainstay evaporated when the son stopped calling clients to seek additional work.

Mentoring the Next Generation

The son had an engineering degree, and was technically capable, but he didn’t understand the financial aspects of business, managing it on a daily basis, or managing staff. The father didn’t prepare his son for his role in running the business, because he felt that he could learn on the job. Unfortunately, he left town when he remarried, and left the company solely in his son’s hands.

Recommendations:

• It is important for the leader of a company to be not only technically adept, but financially literate as well. Courses in business finance and accounting would have prepared the son with an understanding of business finance, giving him the tools to make changes to improve the company’s operations and its profitability.
• Learning how to manage people is just as important in leading a company as understanding the financial reports. Some basic courses in supervision in addition to regular meetings with a business coach would have improved his skills as a manager.
• Mentoring the next generation while giving them increasing responsibilities would have allowed the son to grow into his position, rather than being thrust into it suddenly, with nobody to guide him on how to manage the company day to day.

Even in the best of circumstances, taking over and running a business is difficult work. If the new leader is unprepared, they lack the knowledge of how to move the company forward. Business management is a learned skill. Whether it be operational, managerial, or financial, it takes years to learn how to run a business successfully.

An experienced CFO has the financial and managerial experience to help run a business. In many instances, they provide mentoring to management to help them succeed in areas where they lack experience.