According to the Small Business Association site, there are 28 million small businesses in America — and that number is growing. For many of these entrepreneurs, their business may be their single largest asset. So what happens when it’s time to retire?
Often, the business owner may look to cash out of the business either by selling it or by passing it on to family members. In both instances, the business owner needs to have a succession plan in place well before he or she plans to retire.
Unfortunately, many business owners don’t have a written succession plan. According to the Financial Planning Association/CNBC Business Owner Succession Planning Survey released in 2015, 78 percent of respondents said they plan to sell their businesses to fund their retirement, and that the proceeds are needed to fund 60 percent to 100 percent of their retirement needs. Yet, less than 30 percent actually have a written succession plan.
The goal of a succession plan is to allow an organization to continue to conduct business even in the event of a key individual’s departure — whether that departure is planned (such as through retirement) or unplanned. While business succession planning is critical to the survival and stability of any organization, it also is crucial to the retirement goals of millions of aging baby boomers.
The components of a good succession plan
The main things to think about in a succession plan are who will run the business when you exit, and how the ownership interest will be transferred to future executives.
If the business is a sole proprietorship, it is very important to think early about who will succeed you as leader, and to allow enough time to train your successor.
If the business is family-owned, or you have multiple employees, the decision about who will be your successor becomes more complicated. Some family members or employees may want to be active owners who are deeply integrated in day-to-day operations. Others may want to receive their share of the profits, but not be involved in management. There may also be that family member or employee who wants to be actively involved in management but who may not be suited for the business.
One way to deal with this is to sell shares of the company, giving greater control of the business to trusted employees or family members who are more experienced and active in the business.
Structuring the succession
An important part of many business succession plans is a buy-sell agreement, which will allow a business to continue to operate smoothly when ownership changes occur and will fairly compensate the departing owner for his or her equity in the business.
According to the FPA/CNBC Business Owner Succession Planning Survey, most buy-sell transactions are financed by installment sales (42 percent) and earn-out arrangements (34 percent). Employee stock ownership plans are an option preferred by 14 percent of business owners.
Regardless of the method of succession, it is important to ensure that employees and family members have the liquid funds to purchase the business when you’re ready to sell. A buy-sell agreement should be designed to deal with unexpected events, such as if the owner unexpectedly dies or becomes disabled. In cases where liquidity is an issue, life and disability insurance are common strategies used to ensure liquidity. Key employees purchase insurance for each other and are required to use the proceeds to purchase the owner’s shares from his or her estate.
When valuing the business it’s important to note that it is almost never helpful to use a fixed valuation in a buy-sell agreement. Business values change drastically from year to year based on any number of variables: gross revenues, changes in the tax code, profit margins, the economy, and others. Consider a method based on an earnings multiple or profit margin to determine the valuation of the business.
Finally, but most importantly, use professionals to help you draft your succession plan. This can include an attorney, accountant and financial advisor. Many times business owners want to save on the cost of a properly drafted buy-sell agreement, but these professionals can anticipate issues that you might never think of on your own.
Stepping away from a business that you’ve built can be emotional, but not facing the future isn’t an option. Succession planning is how you ensure the legacy of the business you’ve worked so hard to build.
Read the full article by Kim Jenson at Philadelphia Business Journal.
