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Succession planning goals

Business Succession Planning: Common Goals and What You Need to Do Now

Business owners spend their lives building up their businesses to be successful. With all the blood, sweat, and tears that go into growing a business, it can be hard to let go. Even more so if you don’t really know where to start.

The First Part of Succession Planning? Defining Your Goals

Succession planning starts with goals. A common goal of business owners is that they want to retire. They may want to sell and then retire. They may want to have the next generation of management take over while they are alive and before they retire. 

Alternatively, they may desire that heirs start to step in and take over before or after retirement. Business owners may want to continue working until they cannot anymore, and their heirs will inherit the company upon death. Perhaps they want to create an annuity for their family. 

Everyone has different succession planning goals. There’s infinite permutations here, and thinking it through is important. That would include thinking about tax, legal, logistics, financing, practicality, teams, systems, documentation, processes, and so on.

[Read Transcript]

Hi, thanks for tuning in to another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time. Today, we’re talking about business succession, part two. We talked high level about what it is and why you should care. Some things we’re going to talk about today are some common goals and some things you just got to start thinking about now.

So to start, common goals that we see when we’re talking about businesses, families that have a business, doesn’t matter your age, doesn’t matter the kind of business or really anything else. It’s just what are your goals? And everybody has different goals. So here’s a list of some goals that we encounter in our practice.

The first goal is “I just want to retire and I have not thought about anything else, about how it’s going to happen.” The business is going to close. Is it going to transition? That’s it. Just want to retire.

Second goal that we hear all the time is “We want to pass on shares slowly. We want to get people involved over time, maybe our family, maybe key people.” But that’s the end of it. They haven’t really thought about it.

The next one is “We want a transition, but we want to ease into it. Maybe as I retire, we’ll retire, we’ll downshift, the next generation steps in.” Which I like. It makes sense, but you got to think about how you’re going to do that.

One we always get is, “I want to give all the shares now, during life as a lifetime gift.” And I would, again, direct you to the video on basis – tax basis – on why that is typically not a good idea. An alternative to that is, of course, buying the shares. Buy a person with whom you want the business to transition to, whether it’s family or not, they can buy the shares. That’s a little bit of a better tax standpoint.

Alternatively, people say, “I want to hold on to the shares as long as I live because I want the cash flow coming from it and I want to give it to everybody on death.” And that’s fine. There’s a tax benefit to doing so. But what happens on death? What’s going to happen? How are you going to make that happen? What framework are you putting in place to make sure that we have the right people in the right places, do the right thing at the right time?

An alternative is people say, “I want to sell the business immediately on death or disability. I want my family to have the money.” But they’re not thinking about the fire sale, the fact that a buyer is going to come in and see this completely discombobulated entity that just suffered a very tragic loss to key people or a key person or more than one person, and they’re going to swoop in for a deal. And that’s not good for the family. It’s not good for the estate. So we generally would advise against that.

But it is what it is. If you don’t plan, that’s what’s going to happen. Sometimes people come to us and say, “I want to create an annuity for my family. I want my business to continue for a long time, and I want it to be continuing to operate while my family gets a little cash flow from it in the way of an annuity. Kind of a passive cash flow.” And that is certainly something that could be done, but it has to have the right framework in place, the right thoughtfulness in place.

And the last attitude that we see, and the last goal that we see is “I don’t care. I won’t be here anymore. Let them deal with it.” And that is what it is. People have that feeling. They just don’t want to deal with it. They’re going to let other people deal with it. But that’s not the most effective tax-optimized way to deal with it. Certainly, if you care about the business having any value to share with your family and the estate in the future.

So what has to get done now? Start thinking about getting your documentation up to speed as soon as possible. We’re talking about all your governing documents that we talked about in these prior videos, your employment agreements, your contractor agreements, your customer agreements, your NDAs. You want to get your IP in place. You want to have everything you can in place and well-documented. And of course, the operating agreements, for example, that govern the rights of the parties and how the parties will transition in combination, usually with a trust, that all has to be talked through extensively.

Which brings us to the next thing, which is you need to have CPA on the team to help deal with tax. We have a tax background, but we still work with CPAs regularly as the team sport concept, the trifecta of representation I always reference. Just important to get everybody at the table.

The other professional would be a financial adviser. You want a financial adviser at the table because they have intimate knowledge of your finances, what you need, how much you don’t need, where your assets are. Are they tied up, are they liquid? And they also can help with really important things like insurance. Key man Life insurance. If something happens to you, life insurance can help fund the business or pay the key personnel to stay on the salary that you are making to do the job.

There’s disability insurance, could be lump sum or a monthly payout, very important. There’s tax consequences of that to be mindful of as well. And then there’s overhead insurance, which is if you become disabled in the past, will the business have the necessary overhead income to pay for itself.

That’s something to consider as well, as is business interruption insurance. That was something that maybe people would have liked to have in the pandemic when they were forced out of the business by the disease as well as the government. So having the right people at the table, having the right documents in place, the right planning, thoughtfulness, thinking it through.

In the last video, we talked about key personnel and making sure that the right people in the business, the right vision, they’re vested, they have a reason to stick around and look after the business when you’re gone. And that’s all documented and memorialized now.

And just again, I cannot overemphasize enough, systems, systems, systems. You want your business to be systemized as much as possible. The business should not be dependent on you. That’s where your business value goes down a lot. Because if you’re not there, what really is the business? People are hiring you. Are they not hiring your business? Maybe your customer list, your intellectual property, some key personnel, maybe a website.

But if you don’t have a well-oiled machine, documented how that machine works, then I think that you’re really severely limiting your business value to a buyer. And without all the documentation, all the insurance, everything in place, you’re really making your business vulnerable to not being able to continue for certainly several generations. The statistics are very not good. The next-generation businesses usually fail, and then certainly after the next generation, after that, they fail even more. They’re very eye-opening.

People are not doing this. They’re not doing a good job at it. The more thoughtfulness and mindfulness that you put into it now while you’re alive, you’re well, you’re healthy, the better your family will be later. Thank you again for stopping by and stay tuned for more.

Succession Planning Goals and Five Ways You Can Transfer Ownership of Your Business

To meet your succession planning goals, you need to spell out not only who will take over and reduce any disputes that may pop up between parties. This type of planning is vital for a smooth transition — and to reduce stress if there’s an emergency that transfers the ownership of the business at some point, such as death or illness.

What options are available to you?

Here are some of the most common ways to transfer ownership of your business to help you find the one that’s right for you.

  1. Pass the Business to an Heir

Maybe you have family members who work in your organization and are considering passing the business on to them. There are some definite pros to this arrangement… but also cons.

For example, if there are multiple family members who want to take over the business, you must provide clear instructions regarding who the business will transfer to and how others will be reimbursed. 

Additionally, it’s not a good idea to pass ownership to someone — even family — who is not currently involved in the business. And picking a single successor is always better than picking multiple people, so don’t try to make everyone happy with a power-sharing arrangement.

  1. Sell to a Co-Owner

If you co-own your business, it seems natural to consider the co-owner as the right person to pass the torch to. In many co-owned businesses, there are already agreements in place to cover what happens if the other owner becomes incapacitated or dies, and that agreement is an excellent foundation for a business succession plan.

A buy-sell agreement is the best way to go about meeting succession planning goals like this. In this agreement, the remaining owner agrees to purchase the business interest from the other owner. If this occurs due to death, then this agreement helps to guarantee that fair compensation is given to the family of the deceased.

  1. Sell to an Employee

Yet another option to consider is to sell the business to an employee. This is a case where a buy-sell agreement is again the best option. 

Typically, the employee agrees to purchase the business from you at a prearranged date, or in the event of your disability or death.

  1. Sell Shares Back to the Company

You can also consider an entity purchase plan or stock redemption plan for succession planning. 

In these plans, the business purchases life insurance on the owners, and those earnings are used in the event of one owner’s death to purchase the business interest. This leaves the living owner or owners with a larger share of the business.

  1. Sell to an Outside Party

If there’s no obvious successor to your business, then you may consider selling to an outside party. It’s important to properly prepare your business for sale if this is the route you take, and to make your business as stable as possible to attract outside buyers for top dollar.

Succession Planning Pitfalls You Need to Avoid

While you certainly have succession planning goals you want to meet, there are also a number of succession planning pitfalls you should work to avoid.

Planning Pitfall No. 1: Choosing a Successor

It’s not easy to choose a successor, but there are certain steps you can take to make the process easier for you and everyone else in your organization. 

  • Think about skills and characteristics. Initially, you may think it’s important to find someone to fill your shoes who is exactly like you, but that isn’t always the best path. 

Instead, think about the person as a whole – not simply their characteristics, but their skills too. It’s okay for the successor to your business to be different from you… as long as they have the ability to keep the business successful.

  • Promote from the inside. Remember, successful businesses aren’t run by just one person. It takes a whole team of people to be successful, and chances are there’s a good candidate for succession among those people. 

The benefits of having someone who already understands the company culture and the way the business works are immeasurable to its ongoing success.

  • Shift responsibilities. Once you identify a successor, a plan to transfer responsibilities and decision-making is vital. Why? Because owners often pass on some responsibilities, while refusing to completely give up control.

However, this won’t be an issue with a clear, thorough succession plan that outlines who has which responsibilities and when those responsibilities transfer. Remember: the more you allow the company’s future leader to actually lead, the more likely they are to thrive in their role when you’re gone.

Planning Pitfall No 2: Designing the Plan

Meeting your succession planning goals requires a plan that is realistic and that sets appropriate expectations. You can start the planning process by thinking about goals that create value for your business and then create a plan around delivering on those goals.

Make sure you also communicate the plan to everyone involved, from management to family members that may work for you. Then, be active in the succession plan and transition. This lets others know that the plan must be taken seriously.

Planning Pitfall No. 3: Valuation

A good succession plan involves getting a business valuation. You may think that because it will be years before the succession takes place that you don’t need to have the business valued, but this is a mistake. You cannot make realistic decisions about your business if you don’t know its value. While that value may change over time, a current valuation can help set the benchmark for your planning.

Planning Pitfall No. 4: Financial Planning

Even if you do a good job navigating all of the other pitfalls, this one often gets people. You need more than a roadmap to transition from one leader to the next. You need more than the right leader. You need money.

That means engaging in clear and purposeful financial planning designed to help you ensure that the loss of a key person is not too much to bear and that they are replaceable. Typically, this is funded with life insurance that helps to bridge the gap until the next generation of leaders is ready to fully take the helm.

Bottom line? The more effectively you plan for an eventual succession, the more likely you are to meet your succession planning goals in an economical and minimally disruptive way when it takes place. 

Like all planning, successful business succession planning is a process that takes time. Get started today before it’s too late for your business. We’d be happy to assist. Reach out today to take the first big step forward.