Why Your Business Needs a Succession Plan

Some business owners dream of retiring from their business, cashing out and living comfortably on the proceeds. Others may give little thought to transition, retirement isn't even on their radar. But every business owner needs to anticipate the unexpected, the possibility of a health crisis, or the fact that their interests and goals will change over time.

A succession plan is an essential tool to ensure the continuation of your business, to advance your goals and to protect your future interests.

Transition to Partners

If you have business partners, it may be anticipated that if you depart the business the other partners will assume your role. When you depart, what is the plan for your share or interest in the company?

  • Will you keep your interest in the business and, if so, share in the profits or receive dividends?
  • Will your succession plan give your partners the right to buy you out, or require that they buy you out, or to acquire your shares from your estate? If so, have you defined a formula for valuing your shares?
  • Do you and your partners have a dispute resolution mechanism in place, to try to resolve any disputes that arise expeditiously and without the expense and other complications that would result from litigation?

Transition to Successors

It may be tempting to believe that when you're ready to transition out of your business, your designated successor will be able to take over and run the company. It's rarely that easy. In most businesses identifying a successor is only the first step in what may turn out to be a long process:

  • Evaluation: Once you select a successor, you need to confirm your successor's interest in the position and pay close attention to their aptitude.

  • Training: Training your successor may involve more time and effort than you assume, perhaps taking the form of an apprenticeship, as your successor learns everything that will be involved in managing the business.

  • Mastery: Prior to any transition will want your successor to master all key aspects of running your business.

  • Transition: As complicated as the training process may be, the hardest part of transition may be when your successor shares ideas or plans that differ from your own. Are you able to entertain those ideas objectively, to evaluate whether the successor is demonstrating good leadership or is perhaps proposing to take the business in the wrong direction? Is the successor receptive to your response to their ideas?

If you reach the end of the process with confidence in your successor, that's ideal. But if you lack confidence in the successor, what do you need to do? Will more training and mentoring be sufficient, or will you need to restart the process with somebody else?

Successors Within the Company

If you intend to choose your successor from among the employees of your business, or recruit a successor into the business, you may encounter some common issues:

  • Jealousy: You may have other employees who believe that they will be superior successors for the business, and their response may range from harboring a resentment to seeking a new job, even to trying to sabotage your successor.

  • Retention: If an employee is attractive to you as a successor, odds are they are attractive to other employers as well. What can you do to ensure that your successor stays with your business as you move toward the transition? Might a retention bonus be required? What about stock options or an ownership stake -- if you're comfortable with that idea -- and with what associated terms and restrictions?

  • Feelings of Exclusion: Employees may feel like they're being excluded from the transition plan and process, or that they're not being told key details about a tradition plan and its timeline. In most cases it is beneficial to keep other employees informed about the process, perhaps even holding meetings to provide explanations and status updates.

Many small business owners are reluctant to give away shares of their companies to employees, but the most obvious alternative is to give cash bonuses or incentives, and promising and paying out cash carries its own set of complications, not the least of which is cash flow.

Successors Within Your Family

Succession within the family not only raises many of the same issues as transition to an unrelated employee, it also raises the potential of a host of problems within your family. Sometimes, other employees will be especially resentful of a family member who is designated to head a company that they believe themselves to be much better suited to manage.

Additional issues that are commonly encountered include:

  • Equal or Unequal Inheritance: If you have several children and only one works for the business, if that child becomes your successor is it fair that they inherit the same ownership interest as their siblings who have not devoted their energies to working for, learning, and running the business? But if you take your successor's past work and commitment into consideration, will your other children be angry about inheriting a smaller stake that the successor?

  • Disagreement Over Valuation: If your successor inherits the company while other siblings inherit money or other property, the manner in which the estate values the company and those other assets can become an issue. The value of assets changes over time, and the value of a business can vary enormously based upon the model used for valuation. It's easy for heirs to feel short-changed.

  • Joint Management: If more than one sibling works for the business, it may be tempting to leave them equal shares and equal management authority. Although designating one as having a controlling interest or primary management control may create resentment on the part of the other (or others), joint management is usually a recipe for disaster - conflict, paralysis in decision-making, confusion among employees, clients and customers.

  • Other Employees: Your other employees may have strong feelings about which of your children should manage the business, and their reasons may reflect self-interest over concern for the company. Employees may team up with one sibling or the other.

  • Contests Between Siblings: Siblings may feel that they are in a contest over who will get to take over the business, and some business owners make the process more of a contest than a more thoughtful evaluation of who is best suited to assume control.

Succession Forced by a Crisis

While it is easy to take good health for granted, any one of us can have an unexpected health crisis or accidental injury. A good succession plan will anticipate a crisis that causes your temporary or permanent departure from the business.

It will often make sense for the business to carry life insurance or key man insurance to protect the business in the event that you or another key employee becomes incapacitated (or worse).

Selling Your Business

Your business may be thriving, and it may seem obvious to you that you'll have buyers lining up if you decide to sell. But no matter how well your business is doing, in order to sell you need to find a willing buyer who is both willing to meet your price and your terms of sale. If you're the best asset of your business, potential buyers may wonder what they'll actually be acquiring once you leave the company.

Depending upon your buyer and the size and nature of your business, buyers may expect you to work for the business during a transition period, or have a management team in place that is trained and ready to run the company after the sale. If you are going to self-finance the sale of your business, what will you do if your buyer stops making payments? If you are transitioning out of the business, with the buyer acquiring shares over time, what rights and remedies have you reserved to protect your interests and future?

Legal and Tax Considerations

Any business transition plan should be created with tax consequences in mind. A transition plan that seems superficially acceptable may unnecessarily create taxable events, expose your estate to gift taxes, or create tax obligations in a single tax year that could be structured to your advantage over a longer period.

A business sale will involve a contract governing the sale, and stock transfers may require advance planning. It may be beneficial to utilize more than one class of stock, to structure an employee stock option plan, and to consider any legal and practical consequences of an increased number of shareholders.

Your stakeholders, including shareholders, investors and lenders, need to be kept appropriately aware of your transition plan, its implementation and progress. Accordingly, your transition plan should involve your seeking counsel from your accountant and from a lawyer who is experienced with creating and implementing business succession plans, and possibly also from an expert in business valuation.

Copyright © 2016 Aaron Larson, All rights reserved. No portion of this article may be reproduced without the express written permission of the copyright holder. If you use a quotation, excerpt or paraphrase of this article, except as otherwise authorized in writing by the author of the article you must cite this article as a source for your work and include a link back to the original article from any online materials that incorporate or are derived from the content of this article.

This article was last reviewed or amended on Apr 5, 2018.