Creating one requires flexibility and patience. So start your decision-making process now — before you’re forced to.
EDITOR’S NOTE: This is Part Two of a two-part series on Succession Planning. Part One appeared in the September-October issue.
Family businesses are the backbone of America. About 95 percent of all businesses in America are family or privately held. A 2014 study revealed that there are more than 27 million closely held businesses in the United States, and they account for between 70 and 80 percent of all new jobs. Closely held businesses contribute more than half of our Gross National Product. Yet historically, very few survive beyond the tenure of the founding owner.
Why? The answer is simple: No plan.
There are two events that can disrupt a business:
1. Death or disability of an owner. Every business, no matter how small, should have a plan in place from Day 1 to cover the death or incapacity of any individual whose presence is necessary to make the business function.
2. Retirement of an owner. Proper planning can ensure the continuation of the business and avoid conflict between the remaining owners and their heirs. We have two fundamental issues to resolve. The first is ownership transfer, and the second is management succession. Let’s look at the questions that need to be asked and answered.
First, ownership transfer. Who are the “key” players? Has ownership been promised to anyone other than the current owners? Which family members are currently active in the business? What is their commitment to the business? Has a promise been made about who will succeed to control? Are there family members not involved in the business who want in?
Second, management succession. What type of continuation plan? Pass it to family? Sell to outsiders? Liquidate the assets? How much is the business worth? How will it be valued in the future? How will the plan pay?
Other important questions. Is there a long-term business plan? Why is the business profitable? What are its weaknesses? What is the profitability of the business if you aren’t here to lead it? How will the business’s creditors react if you die or become disabled?
So, what do you do? Business continuation planning must be viewed as a process, not an event. Like a well-run relay race, the handing over of a company should be graceful, carefully strategized and well executed to be successful.
Work with your attorney, CPA or other financial adviser, as well as your insurance agent, to develop a worst-case scenario in the event that the business loses a key person.
Owners should begin planning while still healthy and active in their enterprises. If you wait until you’re forced to retire, you won’t be able to do some of the jobs associated with continuation planning, such as teaching others how the business operates. To begin with, you must decide the method of deposition of company ownership.
- Does it pass by gift to family members? Who pays the tax?
- Should it be sold to involved family members? Do they have the money?
- Should it be sold to a key employee group? Do they have the money?
- Is a reciprocal buyout with a similar company appropriate?
When giving consideration to passing on the business, begin thinking about what you’re going to do when you step out of the business. If you weren’t involved in the company, how much money would you need? Discuss your ideas with your family, management, team and key employees.
As you plan for this succession, identify “trigger” dates when:
a) you want to pass the business on
b) control is shifted (51 percent or more)
c) responsibility of day-to-day operations rests with your successor
d) you plan to formally retire.
Some of the following questions may be considered when establishing your business continuation plan.
- How important is it to you to guarantee that your business will be controlled by the parties you select?
- Would you consider selling the business to key employees?
- Are there any key employees who can afford to buy it?
- Who takes over as CEO or managing director?
- Should there be incentives to retain key employees?
- Should there be an interim board of directors?
- How does the company complete the work-in-progress?
- Do you want severance or transition pay for the employees?
- Who assumes or pays the personal debt guarantees?
- When do you pass on critical bank relationships?
- Who needs key-person life insurance?
- Who takes control of the receivables and payables?
- Who maintains the customer files and database?
Direction of the Company and Strategic Plan.
- Is it best to maintain under family management?
- Is it best to maintain under employee management?
- Should family seek an outside, qualified buyer?
- Can it be preserved for young, noninvolved children?
- Is it best to close the business or liquidate? When?
There are four main continuation-planning choices:
Sell to outsiders. This eliminates the need for succession and may be the only solution when no child or relative wants to take over the business.
Purchase life insurance. Insurance can keep the business afloat until a new leader provides cash to pay estate taxes. Some owners use insurance to reward children who do not plan to work in the business. They pass the business to the children who are active in it and purchase life insurance of equal value for the others.
Draft a buy/sell agreement. This contract between the owner and co-owners, partners or family members spells out the terms of succession, from the value of the business to limits on selling shares to outsiders. It could be triggered when the owner becomes disabled or dies.
Set up a family limited partnership. This allows the owners to maintain control of the business during their lifetimes, while gradually shifting the assets to their children at a discount.
As you set up these contingency plans, it is important to communicate: This means you must discuss with family members your expectations and solicit input from those on the “receiving end.” Have a written plan that includes a training plan for successors. Be flexible and have patience.
The key is to start now. Set a goal to have a plan in place in 90 days. Join a Bottom-Line Impact Group, which brings together non-competing shop owners to discuss ways to increase profits, increase the value of the business and get help with your succession plan.