Secrets of Successful Succession Planning
One of the first questions I ask my small business clients is: “Are you planning on working in your current business forever?”
While this may seem like a silly question with an obvious answer, many business owners have simply never thought about it, and they have no idea how to set themselves up to eventually retire from the business. As a result, they have often created a business model that will make it difficult or impossible to do so.
In addition, in many cases, the business is their primary asset and will be the main source of their retirement income. For that reason, succession planning (sometimes called exit planning) is a critical part of your strategic plan AND your personal financial planning.
A second, related question is: “What will happen to the company if something happens to you?”
If you become temporarily or permanently disabled before retirement, you will want to ensure that the business survives while you’re unable to work, and if you should pass away prematurely, the wellbeing of both your family and your employees will also depend on your planning in this area.
Succession planning is different for every business and every owner, but there are a few general places to start.
Planning for Retirement
To plan succession in a small business due to retirement, permanent disability or death, you have three basic choices:
- Sell to an outsider through an outright sale or a merger;
- Sell to insiders (employees, family members or co-owners) through a buy-sell agreement that is negotiated in advance, or perhaps through an ESOP (Employee Stock Ownership Plan);
- Transition the leadership to a new CEO, but remain in a shareholder role and receive income (or have your family receive income) from the business.
Which one you choose depends on many factors, including:
- The size and type of business;
- The form of ownership and how many shareholders or owners there are;
- Whether or not you have employees or family members who are interested in the business and competent to take over;
- The outside market for that type of business;
- The profitability of the business and cash flow available after paying for professional management, if you keep the business as a shareholder.
Once you’ve identified the most likely path, your strategic and operating plans should start positioning the business for the eventual transition many years before it is actually expected to happen. Many CPA’s, attorneys, and business consultants practice in this area, and you should involve a professional in your planning at an early stage in order to ensure that you’ve considered all the ramifications of your choices.
Planning for Temporary Disability
In a very small company or professional practice where there are no employees or partners to take over leadership if you are disabled, the primary option for handling a temporary disability is a Business Continuation Agreement. These are used extensively for small professional practices and other smaller businesses.
The basic idea of a Business Continuation Agreement is that two business owners with similar businesses agree to “take over” the other’s business for a limited time if the other is disabled. The professional or business owner who provides the services keeps the revenues, but keeps the business going until the disabled individual can return to work.
A Business Continuation Agreement can also be combined with a buy-sell agreement, which is triggered if the disability is permanent or one of the parties dies. Be sure to consult your legal counsel for assistance in drafting these agreements, as there are a lot of issues that need to be agreed upon.
In a larger business, the temporary disability of an owner should be handled by ensuring that there are employees who are capable of taking over a leadership role in the event the owner/CEO is not able to work. If this is not possible, a plan to bring in an interim executive (and a way to pay that person) should be laid out.
In either case, business owners should carry disability income insurance, as it is likely that the company will not be able to pay for interim management and continue to pay the salary of the owner while he or she is disabled. It would be a shame to be forced to sell your business for income due to a disability that is temporary.
It is also a good idea to consider “Key Person” insurance. This is life insurance that is owned by the company on the life of the CEO/Owner. In the event that the CEO/Owner passes away unexpectedly, the company can use the life insurance proceeds to hire outside management to keep the business running.
As you can see, succession planning needs to be an integral part of your overall business strategy. Don’t be one of the many business owners who leave the ultimate fate of their business to chance!
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