Growing your own small business is often likened to having a child. As a small business owner, you are the sole person responsible for starting, cultivating, and scaling the business. It also means that you have a strong incentive to protect your business. It becomes so much necessary to implement your small business succession planning.
As a small business owner, you’ve poured your heart and soul into building your company. But have you thought about what will happen to your business when you’re ready to retire or move on to new ventures? Small business succession planning is a crucial step in ensuring the long-term success of your business. It involves preparing for the transfer of ownership and leadership to the next generation or a new owner.
What is a small business succession plan?
A small business succession planning is something that outlines what should happen to your business in any adversities. The document should include details as to whom your business will transfer to, how, and when.
Many succession planning for business owners include plans for buy-sell agreements when the small business owner does not have a family member to take over the business. The agreement in this case can be secured financially by a life insurance plan or a loan. Unless the business is going to be passed to an heir through the owner’s estate plan, then it is often sold to a co-owner, an employee, or an outside entity.
What happens to a small business when the owner dies?
As a small business owner, your business succession plan is closely tied in with your estate plan. This business interest can be included in your Will, Trust, and other estate planning documents and can be left to an heir or heirs of your choosing.
Why should the small business owner have a succession plan?
A small business owner who cares about the future of their business, and what should happen to it when they pass away, should strive to put a succession plan in place as soon as possible.
This “departure” doesn’t necessarily always mean death or retirement. It can also be a temporary incapacitation such as an illness, or getting stranded in a foreign country, that would bar the owner from managing the business themselves for a short or long duration of time. By having a plan in place, the appointed successor would have the means necessary to take over and manage operations without interruption. This can help the business avoid any breaks in service or production and thus retain clients.
How to develop a succession plan?
Here are some other key points that can be addressed in a succession plan:
To liquidate or not to liquidate
If you were to pass away or retire, would you want the business to continue? Some owners simply want to liquidate assets and close the business. They can pass the proceeds to their heir. Others might want the legacy of their business to continue long after they’re gone. If you choose the latter, you’ll need to choose a successor.
Successorship
A successor is the individual who will take over the owner’s place. This can be a family member, a key employee, or other individual. Not only is it important to designate the successor, you’ll be glad you planned in advance so that you can groom them, provide guidance, and ensure they have the tools and skills necessary to lead the business. This can have positive ripple effects, such as ensuring employees feel secure regarding the future of the company and their employment.
Manage debt
Most business owners have loans and lines of credit to think about. When the owner passes away, the lending institutions have the right to force repayment of the loans. A solid succession plan should include instructions for how to manage debt, such as what funds or assets should be used to repay loans.
Plan taxes
Last but not least, a crafty small business succession plan can also minimize the impact of taxes. For instance, the owner could take advantage of the Tax Relief Act or gift-giving exemptions to help reduce the owner’s tax liability.
Succession planning in small business
Several business owners have a succession plan; however, many have concerns about their selected successor’s ability to grow the business long-term or could result in family in-fighting.
Simply putting a succession plan in place is not always enough. There needs to be a strong strategy in place that can help ensure a smooth transition. A strong succession plan can take a long time to develop and fine-tune, which means that business owners should not procrastinate on this critical process.
Options for small business succession planning
Lets look at some of the small business succession planning options.
Using will or trust
When it comes to a business one need to approach ownership interest from estate planning and succession planning. Ownership interest is personal property. This means to have the option of using a Will or Trust to bequeath your personal interest shares to an heir or heirs of your choosing.
Operating agreement
An operating agreement is a legally-binding document typically used when multiple owners form a company. The agreement addresses who the owners are and how the company is managed, including financial and operational rules and provisions.
Succession plan during life
Also know that one do not necessarily need to wait until retirement or an unexpected incident to do something about ownership interest. One can sell all or most of ownership interest to a third party and take a reduced role in company.
This gives you the ability to start the leadership transition while you are still on board as a manager or advisory member to provide your advice and wisdom.
Buy or sell agreement
A buy or sell agreement is a pre-agreed upon sale between an owner and a third party. The sale is triggered by the death of the current owner, or other type of event. This trigger event causes the ownership interest to be transferred to the third party. The price is agreed upon at the time of signing; it could be a fixed price or based on another valuation method such as fair market value.
Employee handbook
When it comes to succession planning, proper documentation is vital. When you are working with a small team that knows the ins and outs of your business, it’s easy to skip over foundational tasks such as creating an employee handbook or organizational charts. Leave that to the corporations!
However, these formalities are essential to ensuring smooth operations during a time of transition.
What should succession planning for a small business include?
A business succession plan is usually represented by a collection of different documents. Each document in the collection is created with the intention of achieving a certain outcome. Some documents may be for information or education purposes only, while others may be legally binding.
While no two small business succession plans may look the same, here is an overview of what a small business might include in their succession plan:
Succession timeline
Define the timeline under which the succession should take place. This could be a predetermined date, or in certain cases of trigger events such as your death, disability or retirement.
Identify your successor
Naming your successor is an easy decision if you have one family member who is involved in your business and wants to take over. However, this task can be harder when you don’t have a family member successor or work with a team of co-owners. Your successor could be your fellow co-owner, or a key employee that you identify. A successor can also be a third party entity that you sell business interest to.
Clear instructions
Be clear about who will take over the business and how heirs will be compensated. Any instructions regarding your personal net worth should be done through your estate plan.
Business valuation
Knowing valuation of one’s business if wanting to sell is necessary. This is a best practice regardless of succession planning, so it’s great to do anyway. There are many different methods to valuing a method. Be sure to document what method should be used to value your business and ensure your business value is calculated, documented, and updated regularly.
