Why succession planning is crucial for SMEs – with Ian McKnight at BMC
Batchelar McDougall Consulting (BMC) is a specialised structural engineering consultancy based in the South Island that has gone through a transformative process of succession planning. We talk to Chief Executive Ian McKnight about what kick-started the journey, how they navigated significant hurdles, and the purpose and values that underpin how the business operates today.
When did BMC start succession planning and why?
BMC is a relatively young company, formed in Wānaka at the end of 2006 by two founding partners. The business started considering succession meaningfully in 2017 when a smaller practice and its founding partner joined the business as a shareholder and brought his business with him. BMC had decided it wanted to endure beyond the founding directors’ retirement – a decision that sounds simple but is the crucial first step to establish the need for defining the value of the business, a pre-requisite for considering how this value could be defined and transitioned to new owners. It was important that in making this simple decision – to endure beyond the founding directors – that the founding directors understood that to achieve this they would likely have to reprioritise dividend and profit for several years to invest into the business as a system. For a small practice, this investment and effort equation can seem unattractive to founders.
Around the time this decision to endure was made in BMC, the company was approached by two larger organisations to discuss acquisition, but after initial discussion it was clear that the business wasn’t operating in a way that made it easy to communicate or demonstrate its value as a going concern. Sometimes you need a crisis to drive a change in behaviour, and this experience motivated the company to better define and protect its value.
COVID hit at a crucial time for BMC – what did you learn during the pandemic and how did it shape the path ahead?
BMC’s two founding shareholders decided to develop succession pathways from within the business, and over the next several years the new partner's ownership grew and a further two shareholders were introduced from within the business in 2019. Other staff had been identified as potential shareholders, but some had moved on and some were not in a position to do so. When COVID hit in March 2020, BMC had two significant founding shareholders at 35% and 30%, and three smaller shareholders at 20%, 10% and 5%. It might sound like BMC was well on the way, but succession requires far more than a parcel of shares changing hands.
COVID was tough for BMC’s management and shareholder group. There were significant issues to manage and unexpected problems to solve with the sudden deterioration in health of one of our founding shareholders. We weren’t as organised as we thought we were, we didn’t have a deep understanding of the business’s health, we didn’t have a detailed understanding of our work pipeline, and our systems weren’t in a state to support a smooth handover of operations. Ambiguity around key business processes – like how to assess share price, or how key person insurance settlements move through a business to beneficiaries – produced an understandable level of friction. BMC had to value and transition the business during the pandemic which required tough discussions within the shareholder group and the operational team.
Despite everyone’s best intentions, when COVID hit the key element of succession hadn’t occurred – the existing structure didn’t allow the founders to confidently step away and the successors to confidently carry on. We were heavily dependent on individuals and we didn’t have mature systems that could be passed on.
The great risk in speaking on this matter is that you might appear to be critical of those who have gone before. The reality is that we stand on the shoulders of those who worked so hard for so long to get BMC to where it was in 2020 – without their efforts there would be no business to transition and no succession required. It’s important to acknowledge that, and also to accept that sometimes you need to do things differently to continue or to improve. This is different from saying that something has been done wrong. In our case we had to transition from centralised control and close management to decentralised systems based on trust and accountability.
Why is it important to give successors the confidence that the risk they’re taking is well-managed?
Succession is about trust. Generally speaking, in a medium sized professional service provider like BMC with 35 staff, succession involves asking people to borrow money against their family home to buy a slice of the business. This is a big deal for most people, and it throws up one of the key points of difference between founders and successors – founders have endured the long hours, risk, confusion, hope, anxiety and stress of getting a business up and off the ground. Often founders feel like the successors owe them for getting the business to where it is – they took a big risk, now they want to be rewarded for it.
In contrast, successors don’t need to take a big risk, and don’t need to buy into the business, and they don’t owe the founders anything. There’s no point in accentuating the tough time you’ve had for years getting to where you are and trying to convince successors they should suffer like you did. Instead, you need to give successors confidence that the risk you are asking them to accept is well managed. You need to convince them they will earn greater reward in the medium to long term than they would otherwise be able to on their own, and that the business is now stable enough to survive long enough for them to either recover the full amount they borrowed and then some, or for them to then sell their investment on at a gain in the years to come. Other important factors, like culture and job security, fade into the distance if you can’t give people the confidence to put their family home on the line.
Since I joined BMC I’ve heard a lot of discussion on succession both within BMC and from other firms who are trying to sell their business in part to new shareholders or in whole to a company like BMC. Too often people get caught up in what a business should be worth on paper and according to their accountant, but they forget they are asking people to risk their family home – they need more than a spreadsheet with average EBIT and projected loan repayments to justify asking people to roll the dice on their family’s livelihood.
Creating this trust in future rewards, or increasing it, involves being able to transparently demonstrate the mechanisms by which these things will occur – the reward and the longevity. The more trust, the more value can be maintained or transitioned. Things that undermine this trust, or reduce it, remove value from your business. Business ownership, even only partial business ownership, carries increased risk. The harder it is for people to see, understand or scenario-test the mechanisms that manage these risks, the harder it is for them to trust them and see value in them.
How do you educate future shareholders before you ask them to buy in?
One of the most significant changes we made as a business is starting an education programme for potential shareholders. Each year we reach out to staff we think would make good shareholders in the future. They sign non-disclosure agreements and we open our books to them. We talk through the business’s systems, strategy and decision-making, and reflect on performance and what progress we’ve made in the previous year against our strategy. We’ve been doing this for two years now, and we believe it has several benefits:
It shows these people how highly we think of them and trust them. We are sharing information that has previously been off limits, which removes a barrier between them and the shareholders.
Whether or not they become a shareholder, it helps them understand how and why the business operates like it does. They can draw stronger connections between their day-to-day actions and the performance of the business.
It layers the understanding and removes a decision. A potential shareholder might come along to four years of sessions but decline shareholding every time because they’re not in a position to commit. But by the time they are ready financially, they don’t have to drink from the firehose trying to understand the opportunity and risk – they’ve seen the systems, worked within the business for another year, and come back and reviewed it again. They’ve done this multiple times. When they’re ready financially, they’re now making a much simpler decision – “do I commit to this system that I understand and have watched perform for four years, or do I not?” They’re not asking themselves “do I commit to this system that I’m struggling to get my head around and don’t really understand?” We’ve seen this happen in most of the succession situations we see around us – people being put on the spot to make a decision with very little understanding of what they are being asked to commit to.
Operating this way allows us to prepare people for the decision, rather than hoping someone jumps onboard when we suddenly need them.
How do you demonstrate that continuity and stability equals value?
Continuity is hugely valuable to a business, both practically and in the eyes of potential shareholders – no matter how good your systems are in a professional services business, if the leadership team leaves entirely then the business is devalued.
The prospect of a 10% buy-in from a new shareholder with the other 90% remaining stable around them is generally more convincing to someone trying to trust the future performance of a business than a 90% buy-in with only 10% remaining stable. There may be exceptions to this, but our key takeaway is that stability gives confidence. If you want to preserve the value of your business, you need to plan for succession to take a while and you need to communicate these longer-term actions and decisions. 10 years is great, five years is fast and probably risky if you’re starting from scratch, and one year probably won’t work and you probably won’t preserve much value if you do it.
Being able to demonstrate financial stability is also important. Sharing the profit at year-end between two founders is a common mechanism, but it makes it difficult to demonstrate a real history of earnings to the business and bring in new senior staff to equivalent operational roles in a way that achieves appropriate parity.
Why do simple systems matter?
BMC’s earnings history was effectively zero for many years, just as it will be for many consultancies, because the shareholders drew salaries that meant at year-end all profit was paid out. That’s fine if you’re not worried about bringing in anyone new, but it makes it hard to show a history of performance for the business. You can do all the spreadsheeting you want to show what it ‘would have been’ if it were set up differently, but to the eyes of a potential successor you are just adding another layer of interpretation and effort for them to get an answer, and you are adding another layer of questions in their brain – how much should the founders get paid if they’re not on a salary? Will they move to that model, or will they stay on shareholder-employee agreements? They haven’t paid any dividends – why not? Will they pay dividends once I become a shareholder? What happens if we have a low earnings year – do their shareholder salaries have a greater priority than my dividends? How are their performance and remuneration reviewed? Simple, common to all, routine systems with a demonstrated history make your business easier to understand which makes it easier to trust.
Here's what we’ve done to get our systems as simple, common and routine as possible in the past three years:
- Changed our accountant – we use a Christchurch-based accountant that is free from personal relationships with our shareholders.
- Changed our insurance broker for our key person and shareholder insurances to a Christchurch-based broker that is free from personal relationships with the shareholders.
- Re-written our shareholders agreement to reflect the learnings from the past three years, and separated shareholder matters from governance.
- Established systems that support the exit of shareholders, including creating a shareholders trust that can buy out departing shareholders at short notice if need be.
- Appointed a professional external director to chair our board so we operate within best practice.
- Appointed a second external director to provide breadth and experience to our board.
- Rebuilt our culture with an emphasis on purpose and values for decision making, trust, transparency and delegation for execution, and accountability – all of which allow us to give specific and timely feedback.
- Indexed our remuneration to market using Stratpay so we know we’re rewarding our people fairly and can give detailed explanations for individual placement.
- Provided clear pathways in both people and technical leadership so staff can see a future for themselves.
- Invested time and trust in succession – each year we run two evenings of transparent education to our potential shareholders where we open the books, talk through the business’s systems, strategy, decision-making, and reflect on performance and what has happened in the previous year.
- Appointed a systems manager to centralise and professionalise the jobs that had been parted out like IT, health and safety, contracts, policy maintenance, and carbon net zero compliance (this role was hard to justify to ourselves from a cost point of view before we did it, but easy to justify in hindsight when you consider the time saved for billable staff and the improved quality and reduced risk of our work).
- Professionalised our contracts and established a proposal review and release system, as well as a proposal pipeline reporting system (this demonstrably reduces risk and demonstrates a forward workload).
- Actively engaged with our professional indemnity insurer – firstly because we pay them a lot and we were effectively hiding from them, but the more we have engaged, the more proactive learning and risk management is occurring.
- Delegated employment decisions to the staff responsible for managing them – we believe the person responsible for managing the performance of a staff member should have the final say in whether they are employed or not. People should be confident they can trust their team, and be accountable for them.
- Delegated responsibilities as far down as we can. In a medium or large system you can’t do everything yourself. Everyone makes mistakes now and then, but we believe you’re better to help your staff fix the odd issue than trying to do everyone’s work yourself (and still making the mistakes anyway). This means staff have autonomy, trust, and responsibility to grow into. It also means we get more done in less time.
What have you learnt and what advice do you have for others starting or considering their succession planning journey?
We can now spend more time looking for opportunities and less time reacting to situations. By implementing good guidance and systems of trust, we’ve removed time-consuming bottlenecks and improved the quality of our entire business.
Fundamentally, BMC wasn’t ready for succession. The founding shareholders had a business they believed was valuable, but incoming shareholders and potential shareholders couldn’t see that value because the operations were tied to and centralised with the founders.
I am the CEO of BMC, and I am not an engineer. There are plenty of people who disagree with this approach but having the time and ability to work on the business has been invaluable. A real barrier to succession in many consultancies is when the managing director or general manager keeps getting sucked into the projects and operations of the business. This means they don’t spend much-needed time on the business, and they burn out trying to juggle projects and the business. I strongly recommend considering someone who is non-operational to help lead any succession or transformation efforts. While these non-technical staff are additional overheads and some would argue they suck profit out of the business, in our view they are a commitment to succession – a sign that we have invested in the longevity and future value of the business while delivering immediate reward to shareholders.
Each year in my presentation to the Shareholders AGM I show them the money we could be putting in their pocket as dividend if we ran the business as lean as possible. I then work through the ways we can continue to invest in the business instead of stripping out all the profit we can. When I ask the shareholders how they’d like to proceed, investment wins every time.
Having an identity as a consultancy is also crucially important. A lot of organisations (not just consultancies) get caught up waffling their way along with purpose and value statements that have no connection to their operations or context. Our purpose (to add value for our clients and stakeholders) and our values (help people, do a good job, collaborate to achieve the good job) are not placeholders in a prospectus or website – we use them to solve problems and make decisions.
I often talk to our people about what makes us different. I tell them they could be engineers anywhere – they could work for MBIE, for a university, for a massive multinational engineering firm, or for themselves at home. Then I tell them what it means to be a consultancy, and how that differs – how we create, grow and protect our value as a consultancy, and how we look after our four key stakeholders (clients, staff, community and shareholders). This foundational awareness of what makes a consultancy valuable is what incubates your pool of successors. It means that when decision time arrives, you’re not putting a value proposition in front of someone, you’re just asking them if they’re ready financially.
Today, we’re reaping the benefits of this work. Isthmus Group Principal Ralph Johns described the “messy middle” to me a while ago, and it felt like that for a long time – the point where you’re putting in maximum effort but things aren’t manifesting. Then all of a sudden the balance tips – you have three new shareholders, you can demonstrate three years of consistent performance, the board’s agenda is forward-focused and not wading through legacy matters, and you’re into the next round of shareholder education.
It’s taken us at least six years to get to where we are in our succession journey, and we’re not finished – but can you ever be? Now when shares change hands it’s an administrative task that confirms someone’s decision to act on the opportunity they’ve been educated on and had demonstrated to them.