Forbes: Cut Through The Fog: Ten Tests For A Family Business’ Succession Plan

“Bert & I” are stories of Down East Maine by Marshall Dodge and are best known for his dry sense of humor. In story is of how, when two lobstermen, the Captain and his mate, are out pulling pots, a dense fog rolled in. This being the days before radar, they could only rely on printed charts. The captain tells the mate to get the old chart book, but as the Captain open the book to the page they needed, a puff of wind came and blew that loose chart from the old book and into the water. 

“Well now what do we do?” asked the Mate.

“We get moving and get onto this here next chart, is what we do” replied the captain.

So, at its most basic, strategy is a way of thinking that shapes what you are going to do in the future, which is how to get to safety when the fog rolls in. Estate planning is an integral part of that thinking, but too often the strategic implications of the estate plan on the family controlled business is overlooked. 

The Question
How many know that your estate planning is the strategy to achieve your goals for growth, control, protection and succession? 

 An estate planning strategy of complexity for the sake of tax savings and starving the family for income to avoid debt will not achieve your goals in the future, since it has nothing to do with preserving the company as a going concern. Tactics used by professionals, such as the use of Family Limited Partnerships, are all about tax and debt avoidance. The estate plan will render your client’s strategies ineffective if your goal is to transfer control of the company intact in the future. Being able to test whether the estate plan works in your overall strategy both before and during implementation allows you to avoid much of the cost and delays of change after implementation. 

The question “Will my estate planning strategy achieve my goals in the future?” is so board that is not very useful. Here are seven further, clarifying questions to estate planner to generate answers that open your mind to new ways of thinking and get greater value from your professional services in achieving your Goals.

Question 1: Does your Strategy tap a true source of advantage?

Question 2: Is your strategy sufficiently granular about where to seek an     advantage?

Question 3: Does your strategy put you ahead of the trends?

Question 4: Does your strategy rest on privileged insights?

Question 5: Does your strategy embrace uncertainty?

Question 6: does your strategy balance commitment with flexibility?

Question 7: How contaminated is your strategy with biases?

Question 8: Based on the Answers to these Questions, does your Strategy Achieve your Goals in the Future?

The next two are really observations –

9: Strategies do not work if there is no conviction to act on your strategy, and 

10: Strategies need to be translated into an action plan to be effective.

Question 1: Does your Strategy Embrace Uncertainty?
Of these questions, the most critical is “Does your strategy embrace uncertainty?” so I will discuss this question first. For example, in 2010 no one could have predicted that the unified credit would be raised to $5 Million, and no one can predicted exactly how much the unified credit would remain at $5 Million.   Further, no one can tell what the economic future may hold, and if the Dollar declines in value, the inventory of a business may be worth more than the business itself. Some analyst, consultant or other pundit is always making predictions about the future, but unless you are comfortable relying on their crystal ball, only by embracing some uncertainty can your strategy work.

There are three different ways professionals handle uncertainty: Traditionalist, New Realists, or Futurists. 

Traditionalists rely on mathematical projections of what has happened in the recent past, with any errors in the projections due to a lack of greater knowledge, information or expertise. Basically the same solutions that worked in the past will work in the future, so long as you “get a better hammer” of increased resources to drive it home. I find this most often in the basic financial planning models.

New Realists rely on close monitoring for signs of change and rapid response to risks or opportunities when changes occur. Since there “is not strategy, only tactics” it tells nothing about where you are going, what you need to get there or when you arrive. I see this often in the succession planning models for family wealth, both inside and outside of a family controlled business. It is not until the death of a family principle that tactic are decided upon. 

The Futurists, or Scenario Analysis, strategic model is the best way of embracing the uncertainty of the future in the long term (i.e. more than ten years). Scenario analysis is a challenge for you, your family and your business, but the result is your 1) learn from others mistakes, 2) marshal the resources you need to meet risks you can anticipate and 3) have the mental flexibility to cope with those risks and opportunities you cannot anticipate.

Question 2: Does your Strategy Tap a True Source of Advantage?
When considering business strategies, the advantage of a special position or capability is one of the first things that defined. The same is true, though often unrecognized, with families. Your company has a competitive advantage, and you control this scarce resource.   Your competitive advantage may not be recognized at first but things like positional advantage you and your family has because your relationships within the closed markets of suppliers and customers, your conduct inside and outside of the company, and your focus on the family’s involvement and performance in the “business” gives them a relative advantage to the non-family businesses in the marketplace.

These advantages can be fleeting so both the advantages of the business and the advantages of the family must be tested and analyzed to see what would happen if they no longer where a true source of advantage.

Question 3: Is Your Strategy Granular Enough about Where to Compete?
In Mehrdad Baghai’s book Granularity of Growth he shows that 80% of the differential of growth in companies is based on picking the right place to compete, and only 20% is based on how a company competes. The same is true in collecting and other “alternative” investments. Too often, however, the niche that a company or a family seeks to compete in is drawn too broadly; the result is that false data and conclusions are created. 

Chris Bradley, Martin Hirt, and Sven Smit note an example of this when a national retail bank makes a regional effort to grow its retail banking business through better customer satisfaction, and at the end of the initiative, the regional data shows that the retail banking did, indeed, grow so validating the strategy. When, however, the bank looked at the data on a city by city and product by product basis, they found that 90% of the regional growth for the bank was due to new business in one rapidly developing urban center, and that was only in one fast growing product area. The granular data proved that the customer satisfaction model was not the reason for growth, but rather the placement of the bank in a rapidly growing urban center.

Question 4: Does Your Strategy put you ahead of the Trends?
Many forecast the future by projecting out the immediate past performance into the near future. Strategies need to have a deliberate analysis of the trends within and outside of the family, company or other organization. The risk of the internally based predictions is illustrated by Daniel Kahneman’s recent book Think Fast and Slow.  Kahneman recalls a project to revise a textbook and curriculum where, based on the internal projections of the work already done, this group of experts predicted that the project would be a success, and that it would be done in two years. HE then queried a participant who had experience in such projects about his specific experience outside of the internal trends of this group. This expert had supported the conclusion of success and two years the group had come up with, but on consideration of his outside experience, he realized that projects he had experience with had a 40% chance of complete failure, and if it was successful, the average time to completion was seven to ten years. Kahneman then goes on to describe his project in fact took eight years to complete.

Question 5: Does Your Strategy Rest on Privileged Insight?
Gaining insights is always hard to do. I usually begin with a short list of questions that have major implications. These can be personal (what if someone dies suddenly?) to technological (what if there is a process breakthrough?) to macro (what if we enter into a deflationary cycle?). In each case, the question must include data collected from both inside and outside of the family, business and organization, and has to focus on simple but often profound conclusions that offer the insight into how the family, the market and the client will behave in specific situations. 

Question 6: Does your strategy balance commitment and flexibility?
Families and businesses sustain their advantages by being able to commit to a strategy for the very long term. This commitment may be to back a strategy that is high risk, but also very high potential returns, as well as commitment to a very low risk strategy, even though there is a low yield on the investment. Strategies require flexibility also, since when you commit is often not a fixed date. To create real options, there needs to be a strategy that commits to opening opportunities for the family or business as well as the flexibility to take advantage of opportunities when they come your way.

Question 7: How contaminated is your strategy by biases?
We are all products of our past and experiences, so we all have inherent biases towards some things and away from others. Even though it is not possible to avoid biases all together, any strategy needs to recognize how contaminated they are by biases, and how it warps the strategy. Some of the most common biases Chris Bradley, Martin Hirt, and Sven Smit note in their article include:

Over Optimism – This in only looking at the inside data and forecast from there, the most common bias of the “number cruncher” programs and experts in estate planning.

Anchoring – Determining the value based on some arbitrary outside point. An example is when IBM IBM -0.4% gave up the PC operating software since there was no value for the PC for businesses at that time.

Loss Aversion – Avoidance of risk at the expense of those that might lead to opportunities. A classic example is the French loss aversion in 1939 prevented them from taking the opportunity to take on Germany when there was an advantage.

Confirmation Bias – Seeing only what confirms your existing opinion. A recent example is the way that the various warnings on the subprime mortgage investments were ignored by both rating agencies and investors until it was too late.

Herding – This is finding comfort in the crowd, and is the root cause of nearly every financial bubble. This is also a grave issue in estate planning, often under the guise of “best practices” the result is needlessly complex and convoluted plans, documents and operations that do not relate to the goals of the client but rather what the consensus in the industry is at the moment about what “everyone should have/do this”. 

Champion Bias – This is when an idea is accepted or rejected based on who is proposing the idea and not on its own merits. For example, the ratings on wine often have more to do with who is making the call than on the actual quality of the wine itself.

The Halo Effect – This is copying the actions of others on the assumption that what has worked in the past for others will work in the future for you. Obviously lawyers who are trained to rely on case law and statutes for their planning without reference to the goals of the client (or the unique qualities of the specific case) are very susceptible to Halo effect. 

Survivor Bias – Here you only take lessons from those that succeed, and ignore the lessons that can be learned from those who have failed. This ignores the impact that luck and outside events have on strategies.

Conclusion
The Planning for future succession at a family business is like navigating in a fog. Success is only certain after your succession, but testing your strategy helps you cut through the fog.