Business succession planning can be a difficult process in a closely held business where the principal owner is the founder of the company and has more than a financial interest in the company.
Often times, a founder is also emotionally invested in his or her business. The process is complex because it is a series of logistical and financial decisions about who will take over your business when it's time to give up control.
We interviewed four experts in business succession planning for our radio show and podcast. Learn more in our Podcast with the experts over at AGH Advisors.
By creating a business succession plan you are covered if anything unexpected happens and have an organized process for transition, if you are simply planning for the future. A succession plan will reduce the headaches, confusion and monetary loss as your business grapples with a transition. A succession plans makes it clear who will take over the business, reducing any potential disputes between parties. If a purchase is involved, the sale price and purchase terms are also clearly outlined, relieving some of the stress for the departing owner’s family.
The first step is often to identify the ideal successor to take over the business, then determine the best arrangement to facilitate a transfer. There are 5 common ways to transfer ownership of your business:
Passing ownership interests to a family member.
Selling to a co-owner(s)
Selling your business to a key employee.
your business to an entrepreneur outside your organization.
Sell your ownership interests back to the company, then distribute to the remaining co-owners.
Passing Your Business Onto An Heir
Many business owners have the belief that passing a business on to children or family members working in their organization is a simple solution to succession planning.
But this can create a lot of conflict if not planned properly. Passing a business on to a family member can get complicated when you have multiple children, and more than one are interested in taking over the business or what do you do when none of the heirs want to take on ownership? To make this work you need to provide clear instructions on who will take over what, and how other heirs will be compensated.
Making business decisions within a family can get messy. Emotions can get unhinged, especially after an untimely death or disability.
This is compounded by the fact that 2nd generation businesses are risky; only 30% stay afloat after an inheritance.
Selling Your Business to a Co-Owner
If you founded your business with a partner, you might want to see that the partner continues the business by drafting a mutual agreement that, in the event of one owner’s untimely death or disability, the remaining owner(s) will agree to purchase their business interest from their next of kin. This sort or arrangement is called a buy-sell agreement and helps to ensures fair compensation, and allows the remaining co-owner(s) to maintain control of the business.
Selling Your Business to a Key Employee
When you don’t have a co-owner or family member to entrust with your business, a third option is selling it to a key employee instead. Choosing an employee who is experienced running the business, typically a manager you have trained to take over. If you’re concerned about maintaining quality after your departure, a key employee is generally more reliable than an outside buyer. Just remember this takes time and planning. A key employee succession plan often requires a buy-sell agreement.
Your employee will agree to purchase your business at a predetermined retirement date, or in the event of death, disability, or other circumstance that renders you unable to manage the business.
Selling Your Business to an Outside Party
If you decide to sell your business to a outsider, prepare your business for sale well in advance. For example, hire and train a great general manager, formalize your operating procedures, and get all your finances in order. These steps will make your business more stable and turnkey as possible, potentially increasing and valuable to outside buyers.
Selling Your Shares Back to the Company
When a business has multiple owners, selling shares back to the company and then distributing those shares to the remaining co-owners can be done with a “entity purchase plan” or a “stock redemption plan”. Often times this approach is funded with life insurance on each of the co-owners. When one owner dies, the business uses the life insurance proceeds to purchase the business interest from the deceased owner’s estate, thus giving each surviving owner(s) a larger share of the business. If your co-owners purchase your shares directly, they get a “step-up in basis,” which means the stock’s basis is re-valued at its current price. With an entity purchase, the original basis remains, and your co-owners will be liable for potentially higher capital gains. Entity purchases can be beneficial when you have a large number of co-owners. Consult with your accountant and/or lawyer to get a plan like this in place.
Update Your Succession Plan Regularly
Any plan or agreement should be updated periodically to reflect changes to business valuation, and any changes to conditions under which a plan should be put into action.