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Succession Planning for Small Business Owners

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Retiring as a business owner is more complicated than retiring from a typical job. In addition to ensuring that you have adequate retirement income, at some point you will need to transfer your business. Whether you plan to liquidate your business assets, sell your share to a partner, sell the whole company, or pass it along to family, planning can’t wait until the last minute. The right business advisor can help you understand what factors to consider and how to make sound fiscal decisions for the future of your business.


Do You Have a Plan to Transfer Your Business?

Part of running a business is knowing how to transfer ownership when the time comes. Without a solid succession plan, you might struggle to figure out an exit when the time comes. Additionally, your employees, partners and/or family might find themselves in a difficult situation financially and perhaps legally. Your company may suffer as it experiences a challenging transition. In the worst cases, the company could fail and people you care about could be out of a lot of money.

Create a timeline now, outlining the circumstances when a succession would take place and the dates you have in mind.


When Should You Start Succession Planning?

It’s never too early for succession planning. In fact, when you start a business, you should already start thinking about its long term future. Even if you have no plans to retire for many years — or ever — unexpected events can happen. 

Your succession plan will need regular review and adjusting according to your business’s performance, your personal retirement timeline and the economy. Periodic business valuations can inform your plan adjustments. You will need a business valuation during certain times like an IPO or merger, or when you need to apply for a loan. Or, you may wish to learn the value of your company along the way to make good decisions about your retirement income strategy and insurance needs.


How to Get Organized for Succession Planning

In addition to an up-to-date business valuation, you will need thorough and accurate records in order to create a good succession plan. Keeping documents organized also protects your business and employees in the event that you are forced to leave unexpectedly. Keep track of inventory, tax returns, financial records and standard operating procedures. 

In addition, you will need to establish a buy-sell agreement, a legal contract that reallocates business assets if you retire, sell or become unable to continue working. It will come into play if any of a company’s owners decides to sell his or her share or otherwise leave the business. The agreement should formalize information about the company's sale price, the value of each owner’s share and rules for who may or may not buy. 

You will not need a buy-sell agreement in every succession scenario, but it can protect you in unexpected circumstances or interpersonal conflicts.


How to Identify Potential Successors

Perhaps the part of succession planning that most people think about first is naming a successor. If you’re an entrepreneur who started a business or invented something, it can be hard to imagine it in the hands of another. However, many small businesses flourish as they pass from one owner to another.

The key to success — and your peace of mind — is to find the right person or people to carry on your legacy. You want the new owner or owners to possess the necessary skills to succeed, along with the passion and vision. There are several different paths you might choose to transfer your business, each with its own pros and cons.


Sell Your Shares to an Internal Successor 

One option is to sell your shares or ownership interests to a co-owner or key employee. If you founded your company with a partner, you may already have a mutual agreement stating what will happen should one party become incapacitated. The remaining owners will agree to purchase their business interests from you or, should you pass away, your next of kin. If you’re concerned about company integrity, you may also consider a key employee who understands and appreciates your company more than an outside buyer would. 

Either option requires a lot of cash to be kept on-hand. The successor may need to buy out your shares with little notice. Many businesses will fund this kind of transfer with life insurance. Another option is seller financing, in which the successor employee pays a down payment, then makes additional payments according to an agreed upon schedule. You will need to negotiate the exact terms of the loan as part of your succession plan.


Pass on Your Business to a Relative

According to a study by MassMutual, 60 percent of business owners say they plan to divide ownership of their business equally among their children. While you may dream of your legacy being handed down from generation to generation, this form of succession can lead to all kinds of strife as emotions run high. Good planning and documentation in advance can mitigate some of the potential conflict. Long before you plan to leave the company, develop clear instructions on who will take over. Detail compensation plans for the successor as well as other heirs anticipating a portion of the company’s value as their inheritance. 

A buy-sell agreement can lay out the leadership structure and allow some heirs to sell their shares to the others, depending on everyone’s level of involvement. Unfortunately, only about 30 percent of family businesses keep the same name and ownership following an inheritance. The successor may choose to sell, take the company in a new direction, or simply lack the ability to keep it going.


Sell Your Business to an Outside Party

You may choose to sell your business at any point, whether you’re planning to retire or not. Perhaps you’re ready to move on to your next endeavor or demand in your industry is peaking. You will need to demonstrate to a potential buyer that your company is a good investment. The buyer may want to continue running the company, pivot its purpose or liquidate its assets. You may need to prepare to watch your business change dramatically after you step away. 

On the other hand, a buyer might stick to your original plan if you have strong brand recognition. If the company bears your own name, selling could potentially be more challenging, as the buyer will probably wish to change it.


Sell Ownership Back to the Company

If you are one of multiple owners, you may sell your shares back to the company when you retire. If the business owns life insurance on you and you pass away, they could use the proceeds to purchase your shares from your heirs. This option may benefit you more or less than simply selling directly to a partner, depending on whether your company is public, the value of its stock, and the potential capital gains taxes.


How Can a Business Advisor Help You Retire Successfully?

You will need to decide which form of succession best fits your situation and how to fund it. 

For example, the succession may be funded through life insurance, a seller’s note, or other funding options. A business advisor who knows your company’s complete financial picture, as well as your wishes, can guide you to making the best choice. If retirement is still years away, they can guide you to the right decisions day by day, year by year, along the path to a successful transition. Regardless of how long you currently plan to continue work, the time to make a succession plan is today.


Contact BAAP CPAs to talk about the financial future of your small business.

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