According to a recent study by the Center for the Middle Market, 45% of middle market businesses face challenges lining up successors for critical roles in the business.
In our experience, middle market businesses are frequently overly dependent upon owners and a few key executives for core competencies and the company’s strategic vision. This can happen for a number of reasons including budgeting concerns, a desire to keep key decisions in the family, and/or complacency. In addition, owners often don’t realize the negative impact this dependency can have on valuation. As a result, building a leadership bench is not front of mind.
Potential buyers quickly identify this “key person risk” during a sale process — however, middle market owners often do not.
Even if a transfer of control isn’t in the business’ near-term plan, it’s crucial for owners and their senior leadership to identify and develop a bench to fill key executive roles. The bench can be internal existing junior executives that are developed into leaders; external recruits with deep industry knowledge and leadership skills, or a combination of both.
Mitigating Risk and Improving Performance
A change in senior leadership and any key position can have a dramatic negative impact on business performance. Planning the succession processes both pre- and post-departure can lower the risk of unmanaged change and its resultant disruption.
If done right, the succession plan can also be a performance driver. While proper succession and talent planning cannot entirely eliminate macroeconomic risk, selecting and developing the right people can help build an agile, innovative, and motivated executive team and workforce which is focused on improvement initiatives to move the needle on gross margins and EBITDA.
Particularly in high growth situations, succession planning also means understanding the talent needs ahead of the growth curve and the required technical and soft skills needed for new positions.
For example, we recently worked with an HVAC company which was in the middle of a generational hand-off. While there was not a sale planned to a third party, a change of control was planned via a family-based second-generation transfer of ownership.
When we were brought in, the owner’s two sons were already holding title and office as the two most senior executives. This decision had been made by the owner as a matter of family loyalty and was not based on who was a fit for the two senior leadership positions. This is not uncommon in closely held family businesses, but it is certainly not optimal.
At the beginning of our engagement, key non-family executives were leaving, others were threatening to leave, fights were common amongst the executive team, and sales were headed in the wrong direction. The business had routinely generated high margin revenues above $20,000,000 a year. Run rate revenues had sunk below $20,000,000 and margins were compressing.
There were three choices:
- Sell the business outright.
- Recruit outside executives to take over leadership and management of the business so the father could complete his retirement plans.
- Develop the sons into respected leaders who could manage the business for maintenance of gross margins and also lead and inspire the entire team to grow the business beyond what it was under the father’s leadership.
We assessed the sons first with a behavioral tool and then a leadership 360 degree tool. We determined they could be developed into respected leaders, and then took them through our sixteen-week leadership development program. The end result was feedback from nonfamily executives that the company had never had better vision, focus, and a path to growth. The company completed the change of control and we are told they are achieving record growth and profits.
In this case, we were brought in just in time — almost too late. We recommend the analyses and decisions for succession are made well in advance of actually choosing and seating new executives.
How to Prioritize Talent Planning
Building talent pools for key positions should always be part of the resource planning of an organization. This also means analyzing the key soft and technical skills needed to fill key positions and having an evidence-based assessment process (not just gut feel) at the ready to screen candidates. This is not unlike professional sports teams, who always have an eye on available talent and have processes to assess potentials and develop new talent. Building out a bench will help you avoid fire drills and the resulting negative impact on corporate performance.