Plan the Work, Work the Plan
When it’s a business owner’s time to step away, proper succession planning is key in the next generation’s continued success.
Even if your business is running smoothly, even if you've given some thought about who might succeed you, even if you have a child or two who know the company inside and out, you need to create a succession plan.
Many business owners haven't - 58 percent of business owners in a 2016 survey by Wilmington Trust had not created a specific plan, while 11 percent hadn't even thought about succession. Even those approaching retirement were unprepared; 47 percent of those over 65 did not have a plan. The reasons varied but are familiar to most business owners - respondents said they enjoyed running their company; transition was too far in the future to think about; they were too busy; and/or they planned to keep the company in the family anyway.
But it's never too early to start putting a plan in place. A well-constructed succession plan for the future can help your business in the present in areas such as strategic planning, business valuation, and tax planning. It can help you identify key leadership talent and allow sufficient time to prepare individuals for leadership roles. It also, of course, provides a safety net for unexpected health challenges, family emergencies, and departures of key employees.
The consequences of failing to plan can be disastrous. An owner can die and leave debt or tax liability, leading to the family losing the business. Or family disputes could threaten the business's future. Or selling parties may not get full value if the business is sold under duress. The long and short of it: If you want your business to continue when you're not around, you must plan when while you still are.
“There's no specific answer as to when you begin planning,” says Mary Stark-Hood, an attorney and financial planner and president of the Hood Group, a consulting firm in Oak Brook, Ill. “Everything that an entity does in terms of succession planning revolves around what it's trying to accomplish in a specific timeframe. It's specific to a company because it depends on its structure.”
Tom Martin, CPA, managing partner and part of the real estate group at Klatzkin, an accounting and advisory firm in Hamilton, N.J., agrees. “It's never too early to start,” he says. “I would say five years is a good rule of thumb for at least starting to think about your ideas, and that's a definite minimum if you're thinking about selling to an outside third party.”
For family-owned businesses, the starting point is deciding who will assume leadership of the company - whether it be a family member or members, a trusted employee, or outside individual(s).
“Clients and customers are going to need a comfort level, and the new owner may want [the previous leader] to be involved for a year or two to smooth that transition.
- Tom Martin, CPA, managing partner, Klatzkin
Transferring the business to the next generation may seem appealing to family-focused owners, but it's not always simple. Even if the offspring work for the business, “they may not be capable of being CEO, running the company, and making every difficult decision that has to be made'” says Richard B. Taylor, a CPA who's of counsel to HLB Gross Collins, an accounting and advisory firm in Atlanta. “A lot of times, a parent knows that and will sell the business instead of passing it down. They may share some of the proceeds, but they don't want to put their children in a situation to fail. It's hard to have that discussion, but it has to be done. I've been a referee at a few of those meetings in my career, and they're challenging.”
Grooming a talented employee to take the reins is also a possibility, but it carries risks as well. Terry Moore, CCIM, a principal at ACI Apartments in San Diego, had a promising employee in his smaller business subgroup. After she'd worked for him for several years, the two began discussing the possibility of her buying out the practice. As they talked for several years, Moore began treating her as a junior partner of sorts, bringing her to client meetings and giving her more public responsibilities.
The two were probably a year away from developing a formal written agreement when the employee got an unsolicited offer from another company paying much more. “She got a great opportunity, and I'm really happy for her,” says Moore - but he now has to begin the process again.
Don't Try This Alone
“You need a team” to start developing a plan, says Stark-Hood. “You need your attorney, your CPA, and your financial adviser, at the very least. You'll need someone to determine what cash flow you're getting at present, what you're looking for in the future, and how this will impact your taxes moving forward. In structuring a transaction, you want it to be as tax efficient as possible, so you need to have all the players in the room talking to each other.”
A business valuation is essential, no matter who ends up leading the company. It's important even if you're selling to family members, says Martin, for gift tax or estate tax considerations. Outside buyers will examine at least the last five years of your bottom line, and so, he adds, “you might want to work with a business valuation specialist or your accountant early on, because they can often give you pointers to raise the value of your business.”
In some cases, the planning process could even include an executive coach or mediator, particularly if the business is being passed on to family members. “Families can be complicated,” says Taylor. “If there are children who work for the company, do they all get involved in management? Do they each have their own specific role?”
“Dividing assets takes a lot of thought and effort on the part of family members,” adds Stark-Hood. Some family members may have no interest in running the company or who aren't necessarily capable. Parents need to decide how to allocate ownership, as well as determine cash flow for their own retirement and estate planning.
Businesses that are partnerships can also benefit from outside expertise when developing succession plans. Taylor's accounting firm hired an outside consultant 10 years ago to help with the process. The firm created a plan that included a mandatory buyout age and a methodology for dealing with financial and client issues. They also created benchmark dates; two years before your retirement date, for example, Taylor says, you should not have clients who don't have other members of the company involved in their business. “We came up with a lot of metrics,” he says. “A certain knowledge base has to be transferred, and those things work well if you do them like you're supposed to.”
Hewing to his company's mandatory buyout date, Taylor retired in May 2018. He retains an office at the firm and now runs a wealth management practice and develops real estate in South Carolina. “The position I've tried to put myself in is this: I'm available if you need me, but I'm not going to volunteer to do anything unless you ask me,” he says.
Other planning considerations may depend on what type of commercial real estate you practice. For example, says Martin, “if you're a developer, the size and status of the projects you're involved in could have an impact on your planning. How close are they to completion? Are there any potential delays on the horizon?”
Investors need to consider their portfolios and the future value of the types of properties they hold, as well as their location. Properties may need appraisals, says Stark-Hood, as well as environmental inspections. She's even worked with intellectual property issues, where business owners hold patents or developed products and must decide whether they will assign the patent to the new owners. “Every case I've seen is unique to that particular business, how it's structured, who owns it, and the value of the assets,” she says.
Internal factors also affect a business's value. Martin points out that buyers may look at key employees, for example. Are a high percentage of them looking toward retirement as well? How will that affect the company's continuity, and will it be expensive to replace the employees? Technology systems should also be considered. Will new leadership be facing the additional investment of an upgrade?
One crucial component of succession planning: customers and clients. “In a small business,” says Taylor, “a lot of times the good will is tied up in the owner, so a departure could be a huge setback for the customers. But if the owner has done a good job with the transition and has prepared customers for the new owner, there's little disruption.”
“I still have a number of clients who call to ask for advice, but they know I'm not familiar with the details of their business,” he says. He understands long-term clients who need to make a big decision might want input from someone who's been working with them. “But they also know that I don't have to prepare their taxes or financial statements,” he says.
That sort of customer service should be built into the succession timeline. “Clients and customers are going to need a comfort level, and the new owner may want [the previous leader] to be involved for a year or two to smooth that transition,” Says Martin.
That, of course, leads to the timeline itself. “Having a definitive timeline is very important,” Martin says. “Even if you're selling to a family member, they should have some idea of how long you intend to be around. And to what extent full time? Fifty percent? Depending on your role, they may need to replace you or budget to replace your salary. Don't leave it open ended - that could lead to an uncertain or uncomfortable situation.”
It can also create awkwardness with a new leader, he adds. Employees may be confused or have divided loyalties to old and new leadership. “Let people know what's going on - make everything clear and keep them from getting nervous.”
A timetable with a definite departure date also can also create some necessary structure for the person who's stepping away from the business. “I think it's important that they have things that they're looking forward to, something in mind,” Martin says, “whether it's traveling or spending time with family. Leaving a business is difficult - they put so much of themselves into their business, it's a hard thing to think about. If I'm not involved in this business anymore, who am I going to be?”