A Deep Dive Into Business Succession Planning

Thoughtful business succession planning is key to creating an exit strategy that works not only for you but also for the company you're leaving behind.

By understanding and considering the crucial components of a solid succession plan, you can secure a professional legacy while creating a stronger path forward for your successors.

The benefits of succession planning

Whether it's you or a partner leaving the business, planning is key to success. By developing a well-thought-out plan, you can help identify core roles and vacancies, choose skills necessary for business continuity and focus on preparing successors to meet future business needs.

You can also help tie your business succession plan into the company's overall goals so everyone understands their roles once you've left the business.

Ownership transfer options

Before you can determine your specific plan, it's important to understand your options. There are multiple ways to transfer ownership, and the method you use will depend partly on the goals you set once you start planning.

Repurchasing ownership interests

This method is particularly useful if there are legal limitations on who can own the firm. In these cases, it's easier for the company to buy back your shares or interests and sell them to new or rising principals. This methodology supports an ongoing professional enterprise.

Leaving the business to a co-owner

This strategy works if there's a significant age difference between owners or one partner is ready to exit the business well before the other. The optimal way to address this is to outline the buyout provisions in a buy-sell agreement created when you founded the company. A neutral third party could also conduct a business valuation to establish the value of the firm and its associated shares or interests.

Selling to employees

Selling to one employee can be a good option if you have a high-performing team member who's interested in an ownership role. You could also consider selling to a child or other family member who's already involved in the business. Selling the company to all employees typically involves creating an employee stock ownership plan, or ESOP, and transferring company shares into it.

Transferring ownership to an heir

This approach focuses on reducing estate taxes. In this case, transferring shares at book value is the most common method—meaning the company's value equals the shareholders' or owners' equity that appears on the balance sheet.

Selling to an outside party

This method usually involves selling the business to a competitor, complementary firm or financial buyer. Generally, the more strategic the company is to the buyer, the higher the price they're willing to pay. For example, a competitor may view a market position or key customer as crucial to its own expansion.

Succession planning preparation

Once you have a grasp on the types of business transfer options available, you can start creating your plan. While each business will ultimately handle it differently, there are some key steps involved with succession planning (PDF) that can help ensure your company's legacy lives on the way you intended.

Set goals

The first step focuses on both your personal and professional goals. Establish a timeline for how long you'll continue working, as well as what you plan to do after you're no longer with the business. Be clear about your personal wants and needs as you work toward building a solid transition plan.

Consult partners

If there are co-owners, sit down with them to discuss your goals as they relate to the business. You may all want to exit at the same time, or one may want to continue working for the next 20 years. The clearer you make the goals of all owners, the stronger the succession plan will be.

This is also a good time to determine the company's top challenges over the next 5 years so you can choose leaders who are best able to handle them.

Identify new managers

Outline the core competencies necessary to assume leadership roles, and work to identify the people who will fill them. Consider both existing employees and external referrals, and take diversity of talent into consideration.

While it may sound seamless to choose successors who share your same managerial style, it's more ideal to consider a broad range of leadership talent. Once you've determined candidates or a successor, ensure they get the training they need to fill in any gaps in skills and competencies.

Determine an exit strategy

While the most likely candidates to buy the business are co-owners, family members and existing employees, they're not the only options. It's important to consider other ways you could structure your business exit. Have multiple backup plans in place, especially if your primary strategy relies heavily on one person taking over.

Set your succession plan in motion

Once you've considered the important elements, it's time to put your business succession plan (PDF) in motion. Here's how to get started.

Establish a timeline

Get a sense for how long each step of the process should take. When do you want to retire? Will this be a complete, immediate departure or one that's phased out? If it'll happen over time, how long do you anticipate it lasting, and how many steps are involved?

Name your successor

If you're currently the CEO or general manager, who will take over for you? Is it an existing employee, or do you need to hire an external candidate?

Before making a decision, fairly vet all viable succession candidates. If you pass the business to multiple children, determine specific roles and ownership percentages. If your business comprises the bulk of your net worth, you may want to sell it to your successor and distribute the proceeds among heirs.

Train them for success

Create and implement a development program for your successor. Ideally, this person will be in the ownership role for 6 months before you leave so you can address any issues that arise.

Structure the transfer

Work with your attorneys to ensure the plan is sound. While an IRS estate tax exemption minimizes the estate tax issue for many small businesses, the business and its assets or sale proceeds could be tied up in probate for months if the transfer is structured improperly.

Document operating procedures

Make note of all procedures you've used to help ensure your successors align with your methods to produce similar results. This can result in a higher degree of replicability, predictability and peace of mind for new owners.

Value the business

Whatever methodology you decided to use, base your business’s value on relevant industry figures or use a third-party appraisal to determine a fair sale price. This could be a multiple of revenue or of earnings before interest, taxes, depreciation and amortization, also called EBITDA. Establish the value right before the sale occurs or the transition timeline kicks in.

If you're self-financing a sale to an employee or family member, put all the funding agreements in place to support an installment sale, equity buydown or other means. If you're transferring the firm to heirs via a trust or other vehicle, finalize any applicable lending or third-party private investment agreements. If you're using an ESOP, set one up well in advance. If you're selling to an outside party, work with estate and business attorneys to structure the sale in a way that supports your objectives.

Planning for a partner's exit

The dynamics for a partner leaving a business can get complicated—particularly if the partner dies because their heirs may inherit their shares. This means you may end up in a situation where your deceased partner's spouse, child or other heir suddenly becomes your new partner—even if they don't have experience with the business.

To avoid confusion, have a clear succession plan that specifies what happens when a partner leaves. In your agreement, lay out how you'd like things to go by answering a few key questions.

• How much advance notice does a partner need to give before leaving the business?
• Will your business buy out their shares and at what company valuation?
• If your business can't afford to buy out the former partner, can they sell to anyone else or would your company need to approve another buyer?
• Does the former partner agree to train their replacement before leaving?

Also consider setting up a buy-sell agreement with all business partners using life insurance. If a partner dies, the life insurance would pay your business money, which you would then use to buy the deceased partner's shares from their heirs. This way, you’re free to choose your next partner while the surviving heirs get extra money.

The bottom line

Business succession planning is complex and takes time, and there's no one-size-fits-all approach. That's why it's best to engage a trusted financial advisor to help you determine the right succession strategy for your specific needs. Choose one with significant experience in business succession who can provide objectivity and help identify and explore options.

Many entrepreneurs dream of a business that provides enduring value to their family and communities. Follow these succession planning steps to help ensure your own reality matches your dream.