Does Your Key Supplier Have A Succession Plan?

by Varnum LLP
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"Hello Jake, I hate to tell you this but we can't ship your order this week. One of our key suppliers is holding us up."

That's a customer phone call you never want to make. If you are like most companies, a significant supply chain interruption could wreak havoc on your operations. Lines would be shut down, customer orders delayed or terminated, and profits stymied. How likely is it that your business is vulnerable to a serious interruption in supply? According to a recent PricewaterhouseCoopers survey of family-owned businesses, approximately 70 percent do not survive past the first generation, so this type of disruption could be imminent if your supply chain includes such businesses.

Significant OEM's in our region are beginning to focus on the topic of supplier succession planning. Quality and delivery are critical, but years of work to optimize the chain can disappear overnight if a key supplier is unprepared for the retirement, death or disability of its owner. All too often unexpected change results in the close of the business. Reducing the risk of this type of disruption in your supply chain may not be something you thought was in your control. But there are steps you can take to identify the companies in your supply chain that may pose a risk.

The first step is to have thoughtful discussion with each of your key suppliers to understand where they are in the process of planning the transition of their business. Questions that will facilitate your discussion include:

Does the owner have a current business succession plan in place? If not, will he/she agree to put one in place within an agreed upon time frame? You want to know that the supplier has governing documents that are aligned with its business succession plan. For example, who are the company's planned future owners? Do the governing documents clearly state how the future owners will gain ownership interest in the company? If there are multiple owners, is a buy-sell agreement in place? Does the buy-sell agreement suggest how the company will be valued upon the death of an owner?

Does the owner of the company have an estate plan in place? An estate plan typically consists of a Will, Trust Agreement, Durable Power of Attorney and a Designation of Patient Advocate and Living Will. The fiduciaries named in the estate planning documents (i.e., the Personal Representative, Trustee, Agent and Patient Advocate) will have the legal authority to act on the owner's behalf in the event of an incapacity or death. Without these documents in place, a conservatorship and/or guardianship must be obtained through the local Probate Court, which will likely lengthen, or make permanent, the disruption of supply to your business. 

Is the owner's estate plan coordinated with the business succession plan? Fiduciaries named in the owner's estate plan to act on behalf of the company should be the same individual(s) the owner has internally designated to run the company in his or her absence. Without such coordination, a company may end up with a fiduciary that has no prior experience running the company.  This can lead to devastating effects for the supplier and, as a result, your business.

How does the company mentor and train its designated future leader(s)? Preparing a future leader may be one of the most important steps to creating a successful transition of management on an owner's death, disability or retirement. Yet, we find this step is often overlooked. It is never too early to start developing and nurturing future leaders to ensure they are ready to step into the owner's shoes at a moment's notice.

Has the business succession plan been communicated to the management of the company? The manner in which a succession plan is communicated will impact the outcome of the succession plan, sometimes more than the succession plan itself. The PricewaterhouseCoopers survey of family-owned businesses states: "A clearly communicated plan signals that the company is here to stay." This is particularly true when communicating a succession plan to the management (and potential future leaders) of a company. It is imperative to gain the confidence and support of the management team in relation to the succession plan. Otherwise, the company risks driving out important nonfamily members after the departure of an owner.

Is there sufficient liquidity to financially support the owner's family, pay any necessary estate or income tax obligations, and secure the future of the company? Often times, an owner's wealth is tied up in his or her company. For that reason, it is crucial to understand whether there will be enough liquidity in the company to continue to operate after tax and family obligations are met. You want to know the owner has thought this through and has a plan in place.

Subsequent steps to take with your supplier will depend on their answers to the foregoing questions. However, if your key supplier answers "no" to most of these questions and exhibits no interest in putting a succession plan in place, you may want to consider vetting additional suppliers to protect the on-going operation of your business.

Switching focus from your suppliers to your customers, consider this: If your key customer(s) asked you the above questions, would you be prepared, or would you pose a risk to them? Given the growing interest in this area, you may find that having a succession plan in place gives your business a competitive advantage.

All business owners must exit the business at some point. The goal of business succession planning is to have as little disruption to the business (and family) as possible in the event of an owner's incapacity or death. Put your own plan in place, and start the discussion with your key suppliers now.

This article originally appeared in the Grand Rapids Business Journal.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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