Pruning the Tree of Ownership: A Strategic Guide for Business Owners

By Paul Stefunek, Managing Director

Business owners and entrepreneurs often fall back upon metaphors as they attempt to capture the essence of their work. The most pervasive of these is perhaps that of the tree. Investors plant seeds; companies grow and flower; businesses branch out. In all this time, the founder and owner acts as the painstaking arborist who nurses his or her organization from the tender sapling of an idea into a flourishing entity.

A very relevant analogy is that of pruning the ownership tree. As owners and founders grow older, they tend to step back and spend much less time and energy on the daily operations of their business. Ideally, a capable team fills most operational roles to a high degree and hence frees up the founder’s time for more strategic aspects.

It’s the founder’s role, however, in guiding the culture and strategic direction of the business that’s harder to replace. That’s why business ownership periodically needs trimming. An arborist will cut away old branches to provide space for new growth; similarly, business owners, from time to time, need to take a close look at their ownership structures.

When to Prune

Knowing when to prune the ownership tree is as important as knowing how. In this respect, some telling signs or key indicators include:

1. Operational Plateau: Your ownership structure should be reassessed if business growth has become flat or plateaued. New insights can initiate a new spurt of growth.
2. Leadership Transition: Founders or other important leaders of an organization, when preparing to retire or move back, need to set up new leaders; the integration must be complete, and ownership must be aligned to the future course of the firm.
3. Strategic Shifts: If your business is refocusing or expanding into new markets, additional owners who bring experience and networks in the new space should be considered.

Focused Growth and Value Creation

Growth does, and can, come through shedding non-core assets and giving resources to the higher-value components of the business. Not all business is valued equally; some of its parts will be more highly valued than others. It is how we identify and grow high-growth, high-value parts of the business that will create additional value.

Business Structure Considerations

The trimming of the business must be in line with your overall strategy. Consider it from the following angles, then do the following:

1. Distribution of Equity: Make sure that equity distribution supports active engagement from owners. Owners who are actively engaged should have the lion’s share to keep them committed to the company’s success.
2. Governance: Strengthen governance structures so that while the ownership might be shifting, the strategic decisions are being made robustly. This could be achieved by establishing an advisory board or by strengthening the board of directors.
3. Succession Planning: Establish a clear succession plan that describes how leadership and ownership transition will take place. Potential leaders within an organization must be identified, along with steps that can be taken toward developing and integrating them.

Pruning Methods

1. Minority Recapitalizations: This would re-align ownership by minority recapitalization. It sells off minority stakes to key management employees or strategic financial partners to infuse new energy and resources into the business.
2. Buy-Sell Agreements: Use buy-sell agreements to manage ownership transitions in as smooth a manner as possible. Such agreements can specify ahead of time how ownership changes are to be handled, thereby avoiding much uncertainty and potential conflict.
3. Non-core assets divesting: Identify and divest non-core assets to make resources available for the business. This, in turn, will help the business to focus on its core competencies and high-value areas as drivers of growth and profitability.
4. ESOPs: Implement Employee Stock Ownership Plans so that employees have ownership stakes in the company. This may also enhance their commitment by aligning their interests with the company’s success.

Practical Steps for Effective Pruning

The people and teams who have brought the company this far are not to be minimized. At the same time, certain business strategies require sunlight and room to bloom for the next phase of growth. This new growth doesn’t come with a guarantee, but failing to refine at all can result in disinterested and less capable ownership, ensuring the company’s potential is delayed.

It is understood that owners prize experience and their ability to remain somewhat removed from a business, but owners must be educated that this may come at a cost related to the future of their businesses. This is the very delicate process of refining the ownership tree: properly counseling with attorneys, certified public accountants, and mergers and acquisitions advisors.

By considering structures of ownership and focusing on the high value-added parts of the business, owners can make sure that enterprises continue to grow and become even more successful under the leadership of concerned and strategic leaders.

© Copyright 2024 by Paul Stefunek, Managing Director, EdgePoint Capital, merger & acquisition advisors. All rights reserved. Paul can be reached at 216-342-5855 or on the web at www.edgepoint.com.