Business succession planning is making logistical and financial decisions about who will take over your company in the event of your retirement, death, or incapacity. The first stage in creating a succession plan is identifying the best successor to take over the firm, followed by determining the best selling arrangement. This is often accomplished through a buy-sell arrangement guaranteed by a life insurance policy or loan.
There are five common ways to transfer ownership of your business:
- Co-owner: Selling your shares or ownership interests to a co-owner.
- Heir: Passing ownership interests to a family member.
- Key employee: Selling your business to a key employee.
- Outside party: Selling your business to an entrepreneur outside your organization.
- Company: For a business with multiple owners, you can sell your ownership interests back to the company, then distribute them to the remaining owners.
How a Business Succession Plan Works
A business succession plan is a document that provides step-by-step instructions to guide a company through a change of ownership. If a purchase is involved, the selling price and terms are explicitly defined, alleviating the leaving owner’s family of stress. A well-thought-out succession plan seeks to benefit everyone—the retiring owner, the company, the workers, and the successor.
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Selling Your Business to a Co-Owner
If you started your company with a partner or partners, you may be thinking about your co-owners as prospective heirs. Many partnerships include a mutual agreement that, in the case of one owner’s untimely death or disability, the other owners will agree to buy their company interests from their next of kin.
This form of arrangement can assist reduce the hardship of an unexpected shift, both for the company and for family members. A spouse may be interested in maintaining their shares but lack the time or skills to see it through. A buy-sell agreement guarantees that they are fairly compensated while also allowing the surviving co-owners to retain control of the firm.
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Transferring Your Business to an Heir
Choosing an heir as your successor is a common choice for company owners, particularly those who have children or family members working for them. It is seen as an appealing choice for providing for your family by entrusting them with the reins of a profitable, fully running business. Transferring your business to an heir is not without challenges.
Some actions you may take to smoothly transfer your business to a successor are as follows:
- Determine who will take over: This is a straightforward option if just one family member is involved in the business, but it becomes more problematic when numerous family members are interested in taking over.
- Include specific instructions on who will take over and how other heirs will be reimbursed.
- Consider a buy-sell agreement: Many succession plans contain a buy-sell agreement that permits non-active heirs to sell their shares to those who are.
- Determine the future leadership structure: In organizations where several heirs are engaged but only one will take over, you may ease future talks by providing clear instructions on how the structure should appear moving forward.
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Selling Your Business to a Key Employee
When you don’t have a co-owner or a family member to leave your firm to, a key employee may be the best option. Consider hiring individuals that are seasoned, business-savvy, and well-liked by your team to help with the transition. This is when your organizational chart might come in handy. If you’re worried about sustaining quality after you go, a key employee is usually more dependable than an outside buyer.
A buy-sell agreement is required for key staff succession plans, just as it is for selling to a co-owner. Your employee will agree to buy your business when you retire or in the case of your death, incapacity, or other scenario that deems you unable to operate the firm.
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Selling Your Business to a Outside Party
When there is no clear successor to take over, business owners may seek to the community for help: Is there another entrepreneur, or perhaps a rival, who might be interested in purchasing your company? To guarantee that the firm is sold for the correct price, the business value should be calculated correctly and updated on a regular basis.
Some sorts of enterprises find this simpler than others. If you own a more turnkey company, such as a restaurant with a strong general manager, your job is to simply show that it’s a worthwhile investment. They won’t have to get their hands filthy unless they want to, and they should still have time to focus on other business interests.
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Selling Your Shares Back to the Company
Businesses with several owners can choose the fifth option. An “entity purchase plan” or “stock redemption plan” is a contract in which the company buys life insurance for each of the co-owners. When one of the owners dies, the company uses the life insurance money to acquire the dead owner’s business stake from his or her estate, giving each remaining owner a bigger portion of the company.
Succession Planning Tips
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Avoid common mistakes
One of the most common mistakes that business owners make when it comes to succession planning is neglecting to evaluate their strategy on a regular basis. Many things change over time, and in order for your succession plan to be effective, it must be evaluated on a regular basis and modified to reflect any changes.
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Make your succession plan at the right time.
Business owners should begin succession planning at least five years before they plan to retire. Many business owners want to transfer their business to their family members in a way that minimizes tax liability, keeps the business assets in asset-protected structures, maintains cash flow to the business owner after succession, and ensures a successful transition of management to succeeding family members.
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Consider the benefits of succession planning.
The advantages of succession planning include not spending 30 years running and creating a firm just to depart empty-handed. Liquidating and closing up shop—rather than selling out—will be extremely inefficient. The majority of a company’s worth is in its goodwill and intangibles, not in its actual assets.
In conclusion
Many experts advocate starting succession planning three to five years before retirement, but it is never too early to start. Knowing how your business will transition, who will take over, and how heirs and partners will be rewarded are all important steps toward decreasing future stress in the case of an owner’s unexpected exit.
The commentary presented herein contains the opinions of Lions Wealth Management, Inc., a State of Minnesota Registered Investment Advisor. This information should not be relied upon for tax purposes and is based upon sources believed to be reliable. No guarantee is made to the completeness or accuracy of this information. Lions Wealth Management, Inc. shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions contained herein or their use, which do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes, and therefore are not an offer to buy or sell a security. Investments in securities are subject to investment risk, including possible loss of principal. Prices of securities may fluctuate from time to time and may even become valueless. This information has not been tailored to suit any individual.