Small businesses grow through the ingenuity of their owners. An owner’s pride in a flourishing business can make identifying and implementing a succession plan difficult, but addressing succession planning can prevent disastrous outcomes.
Recognizing The Result Of Failure To Plan.
Many owners fail to plan for the inevitable life changes – retirement, incompetency, and death – until it is too late. By not planning for these events, a thriving business can quickly fail.
Many owners delay planning using the excuse that they will simply sell their business when it’s time to retire. Selling a small business is a lengthy and complex process and, even when successful, does not typically yield the desired price. Further, unless the owner can sell to a partner or trusted employee, selling to a third party may leave the business in the wrong hands, upsetting customers and employees.
In the event of an owner’s incompetency, without proper planning, a guardian may be appointed by court based on statutory preference, a process that can take weeks. Moreover, the appointed guardian may not be familiar with the business operations. In the event of death, without proper planning, the owner’s interest in the business passes through probate, potentially leaving a lengthy management void. Without anyone at the helm, employees flee, customers are not serviced, and contracts are not fulfilled, often leading to a “fire sale” of the business.
Moreover, if adult children and/or second spouses are involved, litigation over the control, vision, and the future of the family business may detract from the continuity of the business operations, financially draining the business.
Taking Steps Toward Planning.
There is no “one size fits all” succession plan. Each business presents unique challenges and opportunities. Techniques used in succession planning typically include “Living Trusts,” gifting, succession agreements, buy-sell agreements, compensation planning, management buy-outs, and Employee Stock Option Plans (“ESOPs”). Each technique has advantages and disadvantages which should be explored.
Advisors. A succession plan should be developed with a team of qualified advisors familiar with the business, succession planning techniques, and owner’s goals. The typical team begins with an accountant, an attorney, and a financial advisor.
Identifying Successors. The most difficult aspect of succession planning is identifying successors.
For family businesses, the successors are likely one or more of the children. Structuring succession in family businesses typically focuses on those children who desire to manage the business, through developing a plan to transfer ownership to those children, and fairly providing for any children who are not part of the business. Structuring transfers to children typically include gifts and discounted buy-ins coupled with the owner’s Living Trust.
For small business owners without family options, identifying successors often focuses on key employees. Transfers to key employees are typically accomplished through compensation planning, structured buy-ins, and ESOPs, coupled with life insurance and buy-sell agreements. Transfers to employees are typically gradual, putting in place flexible safeguards in the event the key employees decide to pursue other opportunities.
Stop-Gap Arrangements. Until successors are identified and a plan implemented, the owner should implement “stop gap” measures, such as naming someone in a Living Trust to quickly take over the management in the event of death or incompetency, and/or creating a revocable succession agreement appointing an individual or board to manage the business upon death or incompetency.
Training and Management Responsibility. Once successors have been identified, training and gradually turning over management to the successors becomes crucial, and has the added benefit of allowing the owner to gauge whether the appropriate successors have been identified. As part of the training, routine board meetings regarding the business goals and vision can help guide the successors.
Implementing the Plan. The succession plan should be communicated to the successors and implemented once the owner is confident that the successors are able to independently manage the business.
While succession planning poses unique challenges to owners, with the right guidance and planning, preparing for life changes can help ensure that an owner’s life work does not fail.
Brian K. Steadman, partner, Solomon Dwiggins & Freer