Zen and the Art of Shareholder Succession Planning: Part One

Consider this scenario: You are the chairman of a small, closely held bank and its holding company. One day, you learn that a significant shareholder has passed away. You know the heirs are not interested in the bank and likely will be looking to offload their inherited stock. The shareholder agreement gives the holding company the option to redeem stock following a shareholder’s death, which is exactly what you would like to do — but how will you actually accomplish that?

Or perhaps this scenario: The bank finds itself in the middle of a shareholder schism. Maybe it’s a divorce; maybe it’s a disagreement between cousins (fueled more by emotion and nostalgia than actual logic); or maybe it’s a more fundamental disagreement about the strategic future of the organization. Regardless, you find yourself in need of a strategy to ensure the voting power of the organization is stable.

And, sadly, think about this situation playing out so frequently among small banks today: The organization has an aging shareholder base. None of the next generation of would-be shareholders is interested in the bank, and there are no energetic new investors on the horizon. The shareholders are therefore more interested in liquidating their shares — and perhaps the entire bank — for estate planning purposes than planning for the institution’s future.

Flip through your disaster recovery plan if you like; you will not find a script for these situations in there. But shouldn’t we think about these eventualities in the same way?

Everyone knows the importance of management succession planning, but what about succession planning for the shareholder group? While perhaps less intuitive, more emotional, and certainly less of a focus for bankers and regulators alike, shareholder succession planning (and stocking the toolkit needed to do it effectively) is just as important, particularly if the bank intends to remain independent and avoid a “sale of last resort.”

People die. Relationships fracture. Feelings get hurt. Financial priorities shift. Market realities change. While there is nothing the bank can do to avoid these inevitabilities of life, the bank’s board and management have a fiduciary duty to be prepared to manage the practical implications on the institution. This is a reality for all businesses, certainly, but the innate lack of an easy capital marketplace and rigid regulatory requirements leave closely held banks with far less agility in planning for and responding to shareholder transitions.

In this article series, we will examine various facets of shareholder succession planning, including:

1. What sorts of events should be considered in the plan?
2. What tools should be kept ready to handle succession issues?
3. Who should be involved in the planning process, and how often should it be conducted?
4. What regulatory implications and requirements need to be considered?
5. How and when should individuals who wear multiple hats (e.g., officer, director, shareholder, family member, friend, etc.) appropriately distinguish their roles and duties?

To kick things off, let’s consider what should actually be addressed in a shareholder succession plan. The scenarios described earlier highlight an obvious priority: liquidity. Whether it’s exercising a redemption option following a life event, buying out a problematic shareholder to restore peace, or providing liquidity to shareholders who need it, the bank’s ability to come up with cash is critical. Redemptions are expensive (in terms of both the actual redemption price and the legal, accounting, and compliance expenses involved), and capital often is not available at a moment’s notice.

Second, logistics. All plans should include a comprehensive list of to-dos and how-tos following an event that triggers a shareholder transition. Appropriate communications may need to be sent to remaining shareholders (a common requirement in shareholder agreements). Regulators must be notified, and filing requirement clocks start ticking. “Events of default” under bank stock loans or lines of credit with correspondent lenders might be triggered and require mitigation. Trusted advisors like attorneys and accountants should be notified so they can advise on additional regulatory requirements or financial issues (and frankly, so they can take some of the burden off the bank’s team). And do not forget the importance of messaging significant transitions with bank staff and customers — a lack of transparency can breed uncertainty, which in turn can evolve into dissension and lost confidence.

And finally, emotional intelligence. This is a topic that deals unavoidably with questions of mortality, pride, dignity, and respect. Shareholders can be less predictable (and sometimes less rational) with their feelings toward the investment, and shareholder transitions often occur in the context of emotional life events. Even before those life events happen, the chances of everything going smoothly during the planning process are low. Therefore, “soft skills” must be employed in developing and executing shareholder succession plans, and bank leadership must be prepared to lead with wisdom and compassion through an environment fraught with high emotions and potentially illogical behavior.

I am a fifth-generation community banker. I wish I could say our bank’s longevity can be credited purely to shrewd and dutiful shareholder succession planning, but I know we have also benefited from a fair amount of luck over the last 120 years. But now, as I participate in this exercise with my own family and fellow board members, I am learning to apply to my own reality the tenets of succession planning that I preach to clients. It is not easy, and it often feels downright weird, but it is critical.