According to Paul Lally, lead partner of the business transition group for Wipfli LLP, the “missing middle” is the gap between the entrepreneurial vision that sparks a business’s formation and the long-term vision that ensures a company’s survival. In a preview of “Cross Over the Missing Middle to Secure Succession Plan,” his column in the summer 2019 Pennsylvania CPA Journal, Lally joins us to discuss the psychological reasons why business owners push off succession planning and why it would benefit them to think about it from the minute they open the doors.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript

In his 30 years working with privately owned businesses, our guest today has frequently seen a blind spot in the succession plans put together by his clients. That blind spot or “missing middle,” is the gap between the entrepreneurial vision that sparks a business's formation and the long-term vision that ensures a company's survival. Here to discuss “Cross Over the Missing Middle to Secure Succession Plan,” his Business Succession Planning column in the summer 2019 Pennsylvania CPA Journal is Paul Lally, lead partner of the business transition group for Wipfli LLP in Media.

Your column talks about the missing middle in many private businesses' plans for succession. For the uninitiated, what do you mean when you talk about the missing middle?

[Lally] For most business owners, they start a business or they buy into a business, but talking about the ones, those business owners who start off the business, they start it because they have a vision. They have a skill set. They have a passion. When they begin the business, they begin to think about, "Where can I see this business headed?" Frankly, in the very beginning of starting a business, you're focused on a few things. At the time, it's all risk. You're making very little income, you're not really building any value in the business, and it's that old saying, "Every day you wake up, you're just trying to survive for a period of time." That is the business owners, and that's really... I call that “the wonder phase.” “What does it feel like to become a business owner? What would happen if I ran my own business?”

When you start your own business, most business owners go through what I describe as “the blunder phase,” where you begin to make every mistake possible in running the business, because what you're learning then is how to become a business owner. You read the studies that most businesses fail within the first three years, and that's really where they fail. They fail within that blunder phase because they just keep making mistakes. The businesses that make it out of that phase are the ones that are still making mistakes, but the few things they do right are really starting to pay off, and then they reach this “thunder phase” where the business ... you're starting to grow revenue. It's starting to produce income. You're starting to grow value. You're really starting to hit your stride.

What the missing middle becomes is businesses will transition hands at some point. They're going to transition hands voluntarily or involuntarily, and what we have found is business owners spend so much time as I call it on the proverbial dance floor, working in their business every day. They very rarely have the opportunity to step aside and get up onto the balcony and go, "Where's this business really headed? I had a vision for when I stared it, but what's the vision for it long-term? What's my vision for myself long-term?" That missing middle bridges the gap between that startup business as an entrepreneur to that thriving business that has now taken on a life of its own. The question you begin to ask yourself at the end of the day is, where does this business go at some point beyond me?

You mentioned it a little bit there, but if you could expand upon it: What do you think it is that causes private business owners to lose sight of that gap between business building and succession planning? Is it everyday concerns? There's just too much going on in the everyday? Or is it something bigger?

[Lally] It's something ... I think it's a great question because I think it's a combination of both. The small thing is you're so engulfed every day in learning the business. The business owners we talk to, many times we meet the business owners who started that business because they have a passion, they have a skill set, but they find out over time what they begin to do is begin to put on more hats. They start out, they were a tradesman, they were a professional, but now they're the CEO. Also, they become the chief operating officer, they're also the chief financial officer, they're also the chief technology officer. A lot of business owners will reach a frustration where they go, "You know what? I'm spending 80% of my time in functions that I consider to be of no interest to me, but it's what I have to do to run the business."

They get so entwined with the daily operations that they cannot pull themselves back and they don't make that leap between the entrepreneur to now being that CEO and being able to build a structure and a business that could run if they didn't show up for work on Monday. The bigger issue is, and I think this is such a critical issue for businesses, private business owners: succession planning to a private owner is a dirty word. It's been ingrained in them that succession planning is an event, and they've equated that to "succession means my exit." It denotes all these negative feelings. "My passion, my legacy, my ego. What am I going to do the day I'm not here because I spent my entire career working in the business? What are my passions beyond this business?"

When something creates a negative thought, what's the immediate reaction to that thought? I just ignore it. I just keep kicking the can down the road until a day I feel like ... where business owners run into their problem, when they're not addressing this missing middle, this plan between starting the business and the perpetuation of the business, is they typically will wake up at six o'clock one day and they'll go, "Okay, it's time, and now I want this done by six o'clock this afternoon and I want the best plan with the best structure to the best successor." Now what they're asking themselves to do is address all of these emotional issues, which most business owners will make emotional decisions most of the time, so many practical decisions in a very short time trying to understand all their options, it starts to become overwhelming for them.

That something bigger is to disconnect this thought of succession planning meaning exit versus what succession is: it's a process.

This was a really intriguing line from your column that I saw, and I think it gets into a little bit of what you're saying there about the psychology of succession planning, but it said, "Before crossing the bridge, first be clear about what succession planning is and what it's not." That's pretty interesting. Are there business owners that are unclear about why they need to be proactive about succession planning or what it entails? Or they're not clear on what it is exactly?

[Lally] I think for most of them, most business owners are not addressing their succession planning and listen, there are statistics out there and the statistics would tell you 80% of business owners don't have a succession plan. There's 24 million private businesses approximately in this country. Think about that. The statistics would say 80% of those do not have a transition plan. That's a huge number, and I think around it is they have been ... again, the perception that's been created, is succession is an event, and not only is an event, succession has become synonymous with my exit. In reality, before crossing that ditch, let's be clear on what succession planning is. Succession planning is an understanding of the true transferability of your business. A question we ask our clients a lot of times when we first begin the conversation is, ask yourself before start thinking about succession, ask yourself one simple question: Is your business even transferable?

They start thinking about that and they say, "Well, wait a second. What makes a business transferable?" Well, there's four factors that go into making a business transferable. The business has to be a viable business, it has to be a stable business, it has to be a sustainable business, and it has to be a profitable business, for the most part. Once in a while, you'll get away with missing one of those, but you cannot miss two. All four of those equal making the business transferable, and one of the biggest inhibitors to the transferability of the business is ... what we ask a question around is, what's the riskiest asset to the business? Oftentimes, that riskiest asset is the business owner themselves.

Think about this. You ask a business owner, "If you didn't show up for work on Monday, and you're not coming back, what happens to your business? Does it remain viable, stable, sustainable, and profitable?" The succession planning thought as a process begins to address those over time. Doing everything I ... what it really does, this crossing the missing middle, bridging this gap, it's embedding transition planning into business planning and making small plans and small decisions over a period of time. They need to start thinking about succession planning as not this event but, "Succession planning is something I do every day to make my business more viable, more stable, more sustainable, and more profitable, which makes it transferable."

Once they have their heads wrapped around that, they're dealing with the psychology of the succession plan, what are the key factors that need to be considered in a succession plan? What sort of personnel needs to be involved when you're building the strategy?

[Lally] A lot about going into creating a transition plan is emotional, and remember something: For a lot of these business owners who started a business or have bought into a business, it's all risk. You're taking all the risk in doing that, so every ... the survival of the business is on that entrepreneur's shoulders at the start of that day. What does that create over time? It creates over time a lack of transparency for a lot of these business owners. They don't really communicate to their folks about the vision and the strategy and the goals and then one day... how would they like to perpetuate this business into the future.

The key factors when you start thinking about creating a succession plan is you ask yourself one question, and that goes back to the statement I made a few minutes ago. The first question you ask yourself is mentally, "If I didn't show up for work, would my business continue to operate? For how long and what period of time?" You start to get your arms around that and say, "Okay, how viable, stable, sustainable, and profitable would this business continue to be? What personnel do I need around me to make sure that I'm accomplishing that?"

Example being, a lot of time when we talk to business owners about if you don't show up for work, they immediately think about how the ownership is going to transfer. That's part of it. The primary part of that statement though is, "How will this business continue to operate should I not show up for work on Monday? Do I have the right systems, the right processes? Does my staff know what they need to know to continue to operate this business for the foreseeable future or for a period of time?" The other part of that, too, is, "How am I incentivizing, motivating, and retaining these people to be part of my vision, to be part of my strategy?"

A lot of our clients would tell you they pay their people very well with salary and bonus, and that's great, but what makes them feel like an owner of the business? What makes them feel like they're a part of this vision? That begins the blocking and tackling, and you want people to buy in to your vision. You want people to buy into your strategy and your ability to start to put that on paper. Not only holding people accountable for helping you do that, but holding yourself accountable. A lot of times why business owners don't write business plans is because once they start writing it down, they feel now that it's in writing they're holding themselves accountable. Business owners like to change. They don't like to be held accountable a lot of times.

It starts to create ... what it does, to answer your question, it takes a very entrepreneurial mind-set to a very professional mind-set.

Now, as you write again in the piece, once a succession plan is implemented, that doesn't mean it's complete. What factors might cause you to have to revisit the plan? Do you have to look at it on a regimented basis? Or is it just something that sort of lives on its own and you check it out as it goes?

[Lally] Part of this conversation, the questions that you've been asking, we're dispelling some of the myths around succession planning. Succession planning for a lot of business owners is "the plan." It is now written in concrete. It's irrevocable. When you start thinking of a succession plan as a business plan, there's a term that we've adopted that most of the technology companies use, which is called agile development. Agile development, it sets a plan in motion, but within that plan it is created to predict what-ifs and changes. It is quickly... the plan is flexible and can be changed over time based upon circumstances changing. Whether they're internal circumstances to the business or external circumstances, competitive, economic, your personal objectives change.

We've worked with businesses that have thought, "Hey, over time I want to transition this business to my next gen of employees," or, "I want to transition it to my family," to find out down the road that those family members or those executives aren't interested in taking over the business. Instead of sitting there going, "What do I do now?" they have a plan, but the plan has been created to predict the contingencies, the what-ifs.

We spend a lot of time talking to clients and asking them the what-if questions. What if your key employee who earmarked as your successor stood up tomorrow and said, "I'm leaving?" What's your plan? Do you have a plan? When we say that once the plan is implemented it doesn’t necessarily mean it is complete because your business is like a child. It grows, it develops, it matures, and your plan must be agile enough to change along with the business.

To answer your last question, do not do a transition plan or any type ... if you want to break this perception, think of it as business planning, do not create the business plan, and stick it in your drawer and dust it off five years from now to see how you did. It's something ... you pull it out every year and you sign off on it and say, "Hey, nothing changed this year. I can put it back in my desk drawer." Or, "Hey, this changed a little bit. Let's tweak it." It's a living, breathing, evolving process.

It's interesting, because you said earlier a lot of business owners are sort of waking up one day and then they're thinking, "Oh, okay, well, I think I'm done now," and that's not a good idea. At what point do business owners need to start thinking about their succession plan? Clearly, it's not a sort of “as you head toward retirement” situation. Is it more of you should be thinking of it as early as when you start the business? What's an ideal time? Or does it vary?

[Lally] My tongue-in-cheek comment would be the minute you start the business you start thinking about your succession. Now, that sounds tongue-in-cheek, but look at the public markets. Look at the publicly traded companies. The day they bring their new CEO in, what does that CEO have? A succession strategy. Long-term succession strategy, short-term, what if that CEO throws his hands up or is terminated, what happens to the business? That's a very professional mind-set. My tongue in cheek has some basis of meaning to it, that the day the business starts to thrive, you start thinking about your succession because why... I ask business owners a lot of times in conversations, just to get their reaction, I say, "Would you sell your business?" The immediate reaction you get oftentimes is "No, that's not my intention."

The question we're asking is different. If you put yourself in a mind-set that every day you wake up your business is for sale, mentally what you're then trying to do is create the strongest, best run, most profitable, most valuable business. That's where you start thinking about it. Can you start thinking about it too early? No, we have clients we have worked with that are in their 40s. Their biggest concern isn't about retirement at age 65; their biggest concern is an unforeseen event: should I become disabled or there is a death. There's a statistic that's out there, by the time a business owner reaches the age of 65 years old and hasn't done succession planning, the likelihood of putting a successful transition plan in place is only about 20%.

Where most business owners will begin to think about this is about the age of 50. If you want to put a time, an age on it, they'll start to think about ... now they got to where they are, it may have taken them 20, 25 years to get here, but now they're starting to look at the next 10 years. They're starting to think about ... we're meeting a lot of businesses, by the way, who are in this flux period right now. Years ago, we used to meet with business owners and their first objective was to pass the business along, whether that was to key employees or the family. A lot of business owners who are in that 50-to-55-year-old range now, they're starting to contemplate, "Do I keep the business? Or do I sell the business?" What they are now focusing on is, "What is the best way to perpetuate my legacy into the future and this business I've created?"

Within practicality, once you get within 10 years, I would start. Business owners, listen: If you're three to five years out, there's still a lot of planning, and the reason we say that is when you start early, you have a lot of options. You have a lot of different ways you can do these things. When you start getting closer to that time of that 65 or that 70 or whatever that time period is, when times gets shorter, you start compressing time. You start eliminating and taking options off the table. An option that could have really helped you five years ago may no longer be available when you're within one year of trying to figure this out.

Business owners don't have a problem making decisions every day. They make it in their businesses. Where they get frustrated, when they talk about this type of discussion, is their options. The more options, the more they can make an educated decision. You give a business owner one option because that's all that's left, their immediate reaction is not to like that option because they think it's their only option. It's time, it's all about time.

The more time you have, clearly the more time you have to adjust or make decisions.

Yes, and I would encourage most business owners, too, is where we run into those business owners who have waited too long or have waited now to within a very short period of time, business owners start a business to do two things. To have personal freedom, do what I want, when I want it, how I want to do it. They also want financial freedom. Don't tell me how much I can make and don't tell me how much I can be worth. That is their reward for the risk they're taking.

We have met so many businesses over the years, when they reach that end point, they haven't created the personal freedom they had intended to do because they put on more hats over time than they've taken hats off. They haven't created the financial freedom they expected because the business is still primarily their income generator and most of their net worth is still tied up in the business. What they have done is they've separated their personal financial planning and their wealth from the business, when in fact they're intrinsically connected.