Succession planning: When the boss goes

Succession planning will keep the company afloat

It's hard to think about Apple without Steve Jobs, Virgin without Richard Branson or Berkshire Hathaway without Warren Buffett. But sooner or later there's going to be a changing of the guard and one can only assume that their senior managers know who's going to pick up the reins when the time comes.

Ideally the transfer of responsibility will be seamless, and shareholders and stakeholders will barely notice the turbulence inherent in any change of leadership.

The value of an effective, well-considered succession plan comes into stark relief when a company is faced with a sudden loss of executive leadership. Last year the entire board of Australia's Sundance Resources was killed while flying over the Congo, and in February this year, Italtile CEO Giancarlo Ravazzotti was killed in a plane crash in the Western Cape.

Although he was travelling with several colleagues, Ravazzotti was the only member of the executive team on board, and his responsibilities were almost seamlessly transferred to his father, the company's founder, within a week. It's no surprise that Italtile's share price dropped as news broke of the tragic accident. But it quickly recovered on the news that the company would have a man at the helm with 40 years of experience in the business, and that he would be supported by a financial director with a 20-year history there.

The King III corporate governance regulations for listed companies stipulate that a succession plan should be in place to protect stakeholders and shareholders in case a tragedy befalls a key member of the company, such as the CEO. But many small business and private company owners are too busy trying to manipulate the cellphone, steering wheel and a cup of coffee to have a moment to think about who would take over their business or how it would be run if something happened to them.

It is worth thinking about though, because the sudden loss of a CEO or a managing partner of a small or medium-sized company can have a devastating effect on everyone from the tea lady to the other partners, as well as the widower. It's a compounding disaster that can be circumvented with a bit of foresight and planning.

Somerset Morkel, a wealth management consultant at Alexander Forbes, says often surviving shareholders don't have enough ready cash to buy the former owner's shares. The deceased's estate is then forced to flog them at whatever price it can to pay creditors and other bills. This means the existing shareholders lose control of the business for a fraction of its true value.

Another possibility is that a person who is unsuitable, either in terms of skills or personality, buys a stake in the company - a situation that can lead to an extensive list of critical business disasters.

SMEs can get around these problems by putting in place a buy-and-sell agreement. This involves establishing the price of the company - either informally in an agreement taken by all the shareholders, or by getting it professionally valued by an accountant. Life insurance is then taken out on all the shareholders and a buy-and-sell agreement is put in place. If one of the owners dies, this agreement compels the deceased's estate to sell the shares at the agreed price and it compels the other party - usually the other shareholder or shareholders - to buy the shares at that price. The death benefit proceeds are used to buy out the deceased partner's share and distribute it among the other shareholders.

There are several benefits to this scenario. Firstly, having a price established for business means a time-consuming and easily disputed evaluation doesn't have to take place in the difficult period after a tragedy when emotions are running high and mistakes can easily be made. Having the policies means that there won't be any liquidity issues - so assets won't need to be sold to create sufficient cash flow to keep the company afloat and the creditors at bay. It also means that there is no chance of an unsuitable person buying into the company, which could create clashes of culture and upset the running of operations.

Many big companies make sure that there is an adequate pool of talent available through human resources processes such as internal skills development, and they map where to find skills externally from universities or business schools - or even the competition - if the need arises.

Things get infinitely more complicated when senior leadership positions need to be filled. A good deal of time is needed to ensure at least one competent candidate is available. And when this position is filled, a new successor should be identified or groomed as soon as possible.

The loss of key skills - either through poaching by a competitor who is prepared to pay a premium, or because an employee has died or become disabled - can be devastating for a small company. Ideally, there should never be just one individual who knows how to work the calculator or how to drive the trucks. But for small companies extensive training can be costly - especially if it doesn't always produce results - and the skills needed might be rare and expensive.

One option here is to establish specific funds that pay out bonuses to key employees, either at regular periods or when milestones are reached, and so lock them into the company with financial incentives. This strategy also makes financial provision to bring in a new recruit at a competitive salary if a key employee leaves for whatever reason. It also makes the company attractive to job seekers and ensures that the company can choose the best if a replacement is needed.

An alternative or additional measure is to take out company-initiated life and disability cover on key employees, which would pay for the expense of bringing in the necessary skills if a critical staff member should cease working.

The accident that claimed the entire board of Sundance Resources last year is thankfully something that rarely happens. In fact, many companies have policies in place that prevent members of the executive travelling together. But tragedies do happen - and it's worth taking the time to ensure that there is a plan in place in a worst-case scenario.