Business succession planning involves making decisions about who will take over your business in the event of your death, disability, or retirement. The first step in writing a succession plan is to select the perfect successor to take over the business, followed by determining the best selling arrangement. The departing owner, company, employees, and successors all benefit from a well-crafted succession plan. Read on to learn more about business succession planning and different ways to transfer ownership.
What is a Business Succession Plan?
A business succession plan is an important part of exit planning. It is a document that provides step-by-step instructions to help with a transition of ownership. If a purchase is involved, the sale price and terms are explicitly laid out, easing the burden on the departing owner’s family.
You can learn more about exit planning here: What is exit planning?
When to Create a Business Succession Plan
Succession plans are often linked with retirement, but they can also serve a vital purpose earlier in the life of a business. There are numerous benefits of exit planning. A succession plan can help you avoid difficulties, stress, and financial loss if anything unforeseen occurs to you or a co-owner.
The requirement for a well-written succession plan develops in tandem with the complexity of the firm and the number of individuals affected by the exit. If any of the following apply to you, you should consider developing a succession plan.
- You have complex business operations
- You have a steady stream of contracts
- You want to choose a successor
- You work with a diverse team
Types of Business Succession Planning Strategies
There are various instances in which a company’s ownership can change. The circumstances may determine the type of succession plan you establish.
You may also want to include more than one potential successor in your succession plan to account for unforeseen circumstances, such as illness, accident, or death. The five most prevalent types of small business succession plans are described in detail below.
1. Selling to a Co-Owner
You might be contemplating selling your business to your co-owners if you created your company with a partner or partners. Many partnerships have a mutual agreement that, in the event of the unexpected death or disability of one of the partners, the surviving partners will agree to purchase the business interests of the deceased partner from their next of kin.
It can relieve the stress of a sudden change for both the business and the family. A spouse may want to keep their shares but lacks the time or knowledge to help the company grow. A buy-sell agreement ensures that they are fairly compensated while allowing the surviving co-owners to keep control of the company.
However, a buy-sell arrangement with a co-owner necessitates having a large amount of cash on hand. Your co-owner should theoretically be able to buy out your shares at any time. Many businesses will use life insurance to support this plan. In addition, the corporation can obtain key person insurance, which pays out if a key employee dies or becomes disabled.
2. Handing Over Your Company to an Heir
Choosing an heir as a successor is frequent among business owners, particularly those who have children or family members who work for them. It is viewed as an appealing choice for providing for your family by entrusting them with the reins of a profitable, fully running business.
However, transferring your business to an heir is not without difficulties. This is a simple option if just one family member is interested in taking over, but it becomes more difficult when numerous family members are interested. This makes it important to include instructions for who will inherit the estate and how other heirs will be reimbursed. You can also consider a buy-sell agreement.
In the absence of the right measures, the transition may become chaotic. Plus, making business decisions as a family can be difficult. Emotions can be volatile, especially in the aftermath of a sudden loss or disability.
3. Selling to an Employee
A key employee may be the perfect successor if you do not have a co-owner or family member to entrust with your business. Consider hiring seasoned, business-savvy, and well-liked personnel by your co-workers to help with the transition. This is something that your organizational chart can assist you with. If preserving quality after your departure is a priority, a key employee is usually more dependable than an outside buyer.
A buy-sell agreement is required for a key staff succession plan, just as it is for selling to a co-owner. Your employee will agree to buy your business at a predetermined retirement date or in the event of your death, incapacity, or inability to manage the firm.
However, money again is often an obstacle to crucial employee succession. The majority of employees will not have the financial means to purchase the company.
4. Selling to a Third Party
When there is not a clear successor, business owners may turn to the community for help: Is there another entrepreneur, or perhaps a competitor, who could be interested in buying your company? To guarantee that the firm is sold for the right price, make sure the business value is calculated correctly and updated regularly.
If you own a more turnkey business, such as a restaurant with an excellent general manager, your job is to show that it is a smart investment. Meanwhile, if you own a real estate firm branded under your name, it may be more difficult to sell.
The process of selling a business to a third party is complicated, and you may run into issues such as your business not being as valuable as you expected, a lack of serious purchasers, or your business not being able to sell at all. The best approach is to plan ahead of time, standardize your operational procedures, and get all of your finances in order.
5. Returning Your Stock to the Company
Businesses with several owners can choose an entity purchase plan which is sometimes referred to as a stock redemption plan. It is a contract in which the company buys life insurance for each co-owner. When one of the owners dies, the firm uses the life insurance proceeds to purchase the deceased owner’s business interest from their estate, giving the remaining owners a bigger portion of the company.
A cross-purchase, in which you sell your shares to a co-owner or co-owners, is comparable to an entity purchase plan. However, in most cases, a cross-purchase is the more cost-effective option. When co-owners buy shares directly from the company, they obtain a step-up in basis. As a result, the stock basis is revalued at the current price. The original basis remains with an entity purchase, and your co-owners may be liable for possible higher capital gains.
On the other hand, entity purchases might be advantageous when there are a high number of co-owners. It might be time consuming to draft cross-purchase agreements with each owner. In comparison, an entity purchase agreement is substantially easier to implement. A single-life insurance policy can usually cover each co-owner.
Create Successful Business Succession Plans with Windes
Many business owners overlook succession planning or wait until they are ready to retire. However, it is important to consider what would happen to your business if you could no longer run the day-to-day operations. Most experts advise starting succession planning three to five years before retirement. However, it is never too early to start.
Knowing how your company will transition, who will take over, and how heirs and partners will be compensated are important factors in decreasing future stress in an unexpected retirement. Windes will help you at every step. Connect with Windes today to learn more about business succession planning services.