Dan Reiter, CFP®, CPA, CExP, CVGA
What Is Succession Planning, and When Should You Start?
Succession planning is the act of planning for the transition of your business from you to a successor owner or multiple owners. A well-conceived succession plan properly answers three questions:
Who do you want to sell or transfer your business to?
When do you want to leave?
How much do you need to sell the business for?
According to Business Enterprise Institute founder John Brown, these questions are universal goals that exist for all business owners.[1] No matter the industry, geographic location, type, or structure of your business, you will need to answer these questions.
Even if you cannot envision yourself leaving your business, creating a clearly defined succession plan is important. Why? I know only a few things in life to be true to an absolute degree of certainty. One is that all (and I mean all!) business owners will one day exit their businesses.
Whether one leaves skipping out the door at age 55 or is pulled out the door on a gurney, there is no escaping this existential reality. Another thing? None of us knows when it will happen.
Owners often ask our Kansas City, MO, wealth management firm about the optimal time to sell a business. Should they sell sooner to avoid tax increases? Wait until they reach $X valuation or sales? Sell at the peak of an economic cycle? A number of factors go into the “optimal” timing of when to sell. However, most can be captured in three points:
The external environment (capital availability, interest rates, industry conditions, the economic cycle, etc.)
Readiness of the business to sell
Readiness of the owner to sell
These factors are not likely to be aligned all the time. However, the business owner achieves the best possible result if they can sell a quality, marketable business in a favorable external environment when they are emotionally and financially prepared to leave.
All these factors are bedfellows, but not all are predictable. For example, burnout may result in an owner being ready to exit a business that’s not ready to be taken to market. An economic recession may cause liquidity in the capital markets to evaporate. A health crisis may force an owner (or their spouse!) to re-evaluate their priorities and how they spend their time.
The best time to begin preparing for your eventual exit to give you the best chance of alignment is always now. You can start by focusing on the things you can control.
You cannot control the external market. You may not be ready to exit. However, you can control the readiness of your business to be left. This is why a critical first step in the process is developing a business continuity plan.
What Is Business Continuity Planning?
Business continuity planning is the act of planning or preparing for potential risks that would cause a severe disruption to your company. The potential risks are numerous, but most small business owners commonly face what we will call the five “dismal Ds”: death, disability, divorce, disaster, and disputes.
Any one of these risks could be destructive for you, your family, and all impacted stakeholders. However, four of them (death, disability, divorce, and disputes) are specific to the owner as an individual. While the pain and stress that come from these events can never be eliminated, the good news is that proactive planning can help minimize their impact, both financially and emotionally.
A business continuity plan has two important elements. The first is a well-drafted written buy-sell agreement. The second is written business continuity instructions.
These documents should be drafted, stored in a safe place, and shared with the key personnel you view as critical in the continuation of “business as usual” should any unforeseeable event befall you—particularly death or disability. These documents should also serve as the foundation of your individual business continuity plan and act as a key resource within the organization.
A buy-sell agreement governs how ownership will change hands if a “trigger event” (such as death or disability) occurs.[2] For example, key employees or existing partners may agree to purchase the shares of the owner or partner.
Business continuity instructions provide more detail and “how” things should be executed if such an event happens. For example, instructions may include a list of key advisors, first contacts and actions, management responsibilities, and a description of how the business will be transferred.
The risks associated with not having a business continuity plan are significant. For one, the value of any business is based upon the profits or cash flow expected to be generated in the future.
For example, if the succession of the business will be a sale to a third party, the buyer will estimate the company’s future cash flows to determine the price they are willing to pay. Next, they will consider the risks of those cash flows changing.
If a substantial portion of the business depends on you as the owner being active in it and you die or become disabled, the future expected earnings diminish significantly. Therefore, the price a willing buyer will pay for your business in the event of your death or disability is, at best, considerably reduced. At worst, any realizable value is eliminated. As a result, the business value available for your survivors is destroyed.
Having instructions and a plan in place can help maintain the status quo as much as possible if something were to happen to you. Business continuity instructions, therefore, help keep financial value in the business if a disruption occurs.
How Are Business Continuity and Succession Planning Related?
Being better prepared for a business continuity event is often the product of being intentional in creating and organizing your business succession plan.
Even if you do not plan to transfer your business soon (or at all), it is still important that you have a plan in place for succession. Why? If you plan to receive any exit value from your business at some point, understanding your end goal will help you map out the strategy to get there.
Even if you do not plan to sell, your business will end when YOU do. If you wish for the jobs and legacy you have created to continue once you are gone, you still need to plan for the succession of the business!
Intentional plans to develop and transfer both the ownership and management are critical, as they are not necessarily the same thing. In many cases, the succession plans start years in advance of the actual passing of the torch.
Whether the future leaders are key employees or family members, it is critical that you implement the proper training programs to ensure continuity in the right skills. You should also think about skills beyond the technical side of the business. Employee management, understanding financial reports, and strategic business planning are examples of critical skills that fall outside typical business operations.
To conclude, critically thinking about and designing a strategy for the succession of your business before you need it may be essential to managing the risk of a business disruption due to unforeseen circumstances.
I would also argue that even if you do not have the plans or desire to walk away from the business in the foreseeable future, planning for such an event to occur at some point is critical. It will help protect the business value and ensure such value is available for both your family members and other key stakeholders in the business.
Schedule a 30-minute discovery call to discuss your situation and how we may be able to help.
[1] Exit Planning: The Definitive Guide: Sell Your Business When You Want, for the Money You Need, to the Person You Choose. Brown, John.
[2] Buy Sell Agreements for Closely Held and Family Business Owners. Christopher Mercer.