Welcome to the third installment in our exploration of succession and exit planning for business owners. In our earlier articles, we covered where to start, your personal goals and financial needs, and then dug into the details of conducting gap analyses to determine where you are now vs. where you need to be financially, including your business’s valuation. Now, let’s discuss the next phase in the planning process.
You’ve grasped the importance of these prior steps. Now it’s time to consider whether you want to remain involved in your business in a limited capacity, hand it over to a family member or another individual, or sell it to a third party. You should carefully evaluate this based on your personal long-term desires, financial needs, and the impact on the employees of your business and, potentially, the communities or people your business serves. This may require some soul searching and certainly isn’t something to be taken lightly, as it involves your life’s work and potentially many other people’s lives. After careful consideration, you should work to a point where you determine whether it’s internal succession or a third-party sale that makes the most sense. Below, we’ll focus on internal succession and elaborate on a third-party sale in an upcoming installment.
Step 1: Define and Communicate with Your Successor
As we move forward with your planning, one of the key steps is identifying your successor. It might seem straightforward, but deciding on a third-party exit or an internal transition is pivotal. Many business owners lean toward internal succession, especially when family members or a trusted management team are in the picture.
If you’re considering internal succession, several important aspects must be considered. First, are the folks you have in mind even aware of your intentions? Will it be a single person or group of employees best positioned to take over ownership? It’s critical to ensure that your potential successors know your intentions to have them take over ownership and leadership of your business.
You’d be surprised how often this step gets skipped over. I recently worked with a business owner who planned to hand over the business to a key management team member. The catch? That person had no clue they were being considered and, in the end, didn’t want to take on the responsibility.
This situation underscores the importance of having open and honest conversations with your potential successors. Once you’ve identified someone, get their input on whether they’re up for the task. Some might shine in their current roles but may not want the full weight of running the business.
Step 2: Assess If Your Successor Needs to Be Trained
After you’ve confirmed that your chosen successor is interested, there are some fundamental elements you need to address. First, consider whether they’ll require any additional training. Do they already have the necessary skills but need to deepen their expertise in certain areas? If that’s the case, setting up a timeline for their training is crucial. Adequate preparation is essential for them to run the business effectively.
Once you have identified your potential successor, create a detailed plan for their training if training and development are needed. Pinpoint any areas where they might be lacking or specific responsibilities they’re not quite ready to handle yet. While this may seem tedious initially, think about the long-term benefits. By planning their transition into a more prominent leadership role and sharing insights from your own experiences, you can ensure your company will be in excellent hands.
What to Do If You Plan to Name a Family Member as Your Successor
If your successor is a family member, like a son or daughter already working in the business, family dynamics inevitably come into play. Considering how this decision will impact other family members who aren’t taking on leadership roles is essential. Balancing the estate plan is crucial to ensure fairness and avoid conflicts within the family.
Bringing in professionals — such as financial planners and legal advisors specializing in succession planning — can be incredibly helpful. They can guide you in creating a comprehensive estate plan and developing strategies to equalize inheritances among family members. This way, you can ensure a smooth transition without sparking internal strife. Plus, an outside perspective can be invaluable — it can help you work through the finer details logically and reasonably.
Step 3: Create a Succession Plan Built for Success
Another key aspect of succession planning is determining how to structure the transition. What will the buyout look like? Will it be a one-time deal, involve some form of ongoing company ownership, like an Employee Stock Ownership Plan (ESOP), or will there be some form of earn-out or installment payments? You’ll need to determine if your successor has the financial capabilities to handle a buyout.
Many business owners worry about leaving their company to a deserving employee. You might trust their skills but doubt if they have the financial resources for a buyout. Luckily, there are planning options available. For example, an ESOP could allow you to loan money to the business for the buyout or find financing through other channels. Understanding the structure of the buyout, the necessary training, and potential funding sources is crucial.
As you develop your strategy, decide whether the buyout will be a single transaction or a phased approach. Will you stay involved in the business for a while or make a clean exit? Being clear about your intentions — whether you’re planning a complete departure or a step-back role — is essential for effective planning.
Step 4: Determine What Your Business Is Truly Worth
Next, let’s talk about the crucial aspect of business valuation. Knowing the value of your business is key. What method will you use for the valuation, and how will you get everyone on the same page? Bringing in a valuation specialist or tax accountant with experience in this area can offer you valuable insights.
If You Opt for a Buyout, Don’t Forget About Assessing the Tax Implications
Let’s dive into the tax implications of the buyout. How will this impact your financial situation, and will the net amount received be enough for your financial needs, as determined in the prior steps discussed? Knowing the tax consequences is crucial for a smooth transition.
Work with an accountant who knows the ins and outs of tax law to understand how the buyout might affect your taxes. They’re generally best positioned to run tax estimates and can work closely with your other advisors to formulate the best strategy to help minimize the tax bill.
Step 5: Develop a Comprehensive Plan for Your Succession
Once you’ve got the green light from your potential successor, it’s time to lay out a comprehensive plan; this should spell out the specific training they’ll need and a realistic timeline to fill in any gaps in their expertise. This step is especially crucial when considering family members for leadership roles. As mentioned, family dynamics can get tricky, especially if other siblings or relatives aren’t in line for leadership.
Summarizing the Things to Consider Financially to Ensure a Smooth Buyout Process
It’s a good idea to bring in professionals, such as financial planners or succession specialists, to manage complexities effectively. They can help craft a solid estate plan that matches your objectives. It’s also crucial to grasp the financial aspects of a buyout. Think about how the buyout will be structured. Assessing whether your potential successor has the financial ability to pull off the buyout is key.
For many business owners, a big concern is ensuring the successor has the resources to take over seamlessly. Younger employees might not have the financial means to handle a buyout. If this is the case, consider funding methods that could still accommodate the buyout. And let’s not forget about the taxes!
Legal Considerations Based on Your Business’s Structure
When it comes to legal aspects, they’re just as important. Depending on how your business is set up, shifting from an S Corporation to a C Corporation might make the buyout easier. Depending on your situation, you could also look into family-limited partnerships or dynasty trusts.
Ensure Fair Compensation to Keep Your Successor Engaged
Selecting the proper successor is just the start. It’s equally important to compensate them so they stay motivated throughout the transition. If there are delays in the process, consider offering retention bonuses or other incentives to keep their interest alive.
Always Have a Backup Plan
Having a backup plan — or two — is essential if your primary successor can’t take on the role due to unexpected issues like health problems or personal matters. The longer your succession timeline, the better prepared you’ll be to handle any surprises that come your way. You’ll also want to have business continuity plans if something unfortunate, like death or disability, happens to you or your successor before the business transition. More on this will come in future installments.
With These Steps and Tips, You’re on the Path to a Smooth Transition
Whether you’re going for an internal succession plan or looking at a third-party sale, you must consider various factors: training requirements, financial capabilities, legal implications, and potential exit strategies. Putting in the groundwork and consulting with the right professionals can pave the way for a smoother transition, hitting your goals while keeping the business’s future secure.
Jerry Maddaluna is the founder and lead financial advisor/financial planner at Luna Financial Group. Luna Financial Group engages in comprehensive financial planning partnerships with business owners to provide personal financial planning, outsourced personal CFO services, and assist with business planning needs, such as retirement plans, buy-sell planning, organizational structure, income tax planning and reduction strategies, optimizing valuations, employee retention strategies, and succession/exit planning.
