Business owners can be so concerned with day-to-day operations they fail to prepare for the inevitable day when they can no longer run their business. “Someday I’ll get to it.” Someday is now. There always seems to be time until there is no more time.
According to Kiplinger, business succession planning may be the “single most neglected aspect” of running a business. Whether plans to depart the business are imminent or far-off, act now, as proper business succession planning can often take several years to implement. The following are some business succession basics, including common planning techniques to consider.
What Events Trigger Business Succession?
A business interest can change hands for several reasons, not just because the founder is ready to retire. Business succession may take place when the owner:
- receives an attractive offer to buy the business;
- receives an offer to join another company;
- is not happy with the direction of the business, the market, or the economy;
- is suffering from poor health or a disability; or
- wants to take their career in a different direction.
Departing owners who do not plan to transfer their business interest through gifting and who need to fund their retirement may contemplate selling. Businesses with some or all of the following characteristics are often more attractive to buyers:
- a history of profitability;
- an advantageous location;
- an industry with a promising future;
- quality inventory; and
- a strong customer base.
Even if all of these elements are in place, a question remains: Can the business operate effectively absent the owner? Sometimes the owner is synonymous and eponymous with the business to where it can barely exist without them. A business may not be attractive to buyers because it is too small, lacks assets, or has declining profits even with significant assets. The better plan for such a business may be to sell only the business’ assets.
Methods of Business Succession
More business owners have set up succession arrangements over the last decade but 30% of them still do not have a formal plan according to a Northern Trust survey. Those with a succession plan should revisit it regularly to ensure that it is updated and relevant.
A business ownership stake can be transferred to a co-owner, a key employee, or a beneficiary or heir of the owner. It could also be sold to an outside party or to the company for distribution to the remaining shareholders.
Some planners advocate that a business owner have a solid business succession plan in place at least five years before the owner wants to retire. As with creating an estate plan, it is never too early to start.
The following steps are often part of an effective business succession plan:
- Establish a timeline with incremental action steps;
- Identify possible successors;
- Formalize the business’ operating procedures;
- Determine the methods for valuating the business; and
- Create a plan to fund the succession.
Valuation and the Psychology of Ending One’s Life Work
Valuating the business can present a Goldilocks problem of finding the number that is just right. The value of a business should be high enough to compensate the outgoing owner adequately, but low enough to be affordable if a family member or key employee will be the successor.
Business succession is not just a matter of money; it is also about legacy. The outgoing owner has poured their efforts into what may have been their life’s work, and now that work is ending. While the owner will be leaving the seat of company power, they may want to leave a lasting mark on the firm. A way to consider helping the outgoing owner deal with the feelings about giving up control of the company, and a way that would be beneficial for the business of the company, is to keep the founder in an emeritus role in the company, allowing them to retain an office and a salary. The founder could continue to help produce business gains because of their reputation and relationships built over the years.
The Process of Business Succession
When the time is right to start the succession planning process, the owner meets with an attorney, accountant, and a consultant to create a road map for transitioning the business. Estate and business planning attorneys call this a “design meeting,” which will include an examination of the plan’s economic feasibility. Preparing the documents could take four to nine months, which provides ample time for the potential successor to be vetted by an outside source if necessary. Placing a value on the business can be difficult because it will likely change upon the departure of the outgoing owner. As an example, the business’ value may be five to seven times the company’s earnings before interest, tax, depreciation, and amortization (EBITDA), but it depends upon each business’ unique circumstances.
Besides a valuation of the business, the plan will often include the rate of sell-down by the outgoing owner and buy-in by the incoming owner. An executive committee may run the company during the succession process. The plan should also establish a timetable to complete the transition.
The first document for the business succession planning will be an outline, which describes the price, what is being sold, what is not being sold, the payment method, compensation, and action timetable.
Other business succession documents may include:
- Equity Purchase Agreement with full financial disclosure;
- Stock Pledge Agreement and Assignment of Ownership Interests; and
- Buy-Sell Agreement with the documents below as exhibits:
- Confidentiality Agreement;
- Covenant Not to Compete; and
- Corporate or other legal entity resolutions to support the transition.
Act – now. “Someday” is not a day of the week. Set a date certain you will make the phone call that begins your business succession planning. If you have an interest in a business succession plan, contact us at (813) 852-6500 to schedule an introductory conference with one of our attorneys for planning your exit from that great business you have built over the years.