One of the worst mistakes a business owner can make is to avoid thinking about an exit strategy or succession planning for the business until they want to retire. While your business may be a labor of love, it’s important to look ahead ten, twenty or thirty years and honestly assess whether you think you will still want to be working at your business.
Some business owners know they never want to retire. Others know they want to retire at some point, and so it’s important to know whether you will eventually sell your business or find a successor to fill your shoes. If you don’t figure this out in the early stages of your business, you could be stuck in your business as an irreplaceable figurehead or specialized skilled labor that the value of your business depends on—with no profitable financial exit strategy you can pull off without destroying the value of your business.
Key Questions to Explore When Succession Planning
When you think about transitioning out of a business you’ve worked on for decades, Steve McLemore, Engagement Director of Goering Center for Family and Private Business says it’s important you get past the superficial things you want and ask more probing questions. Do you plan to work or play golf for the rest of your life? McLemore asks you to go deeper and ask, “Is that really what you want for your legacy?” He advises to ask what you want for yourself, your family, your children, but also your business: your successor, employees, vendors, and partners.
McLemore says preparing to transition your business can be a two to ten-year process because it takes time to establish safe relationships to have these deep conversations. You need to be able to answer the question, “What do you want?” with authenticity and clarity.
Can Your Business Run Without You?
For your business to be sustainable by definition, it needs to be able to function well without you. What can you do now to make retirement work? Can you successfully take a 90-day sabbatical and have your business run well without you? If it can, your business is worth more.
McLemore encourages you to ask, “What can you do to make sure your business can thrive without you?” If you take a vacation and your business fails or your employees need your advice or expertise, you definitely need to ask, “What kind of experiences do potential successors need to have in order to fill your shoes once you leave the business?”
What Can You Afford to Do?
How do you want to spend the next few decades of your life? You’ll need a certain amount of money to live well for the rest of your life. McLemore says you will need to come up with a number in order to put the first stake in the ground: what is the date of your retirement, and what is the amount of money you need to make retirement feel financially comfortable? Then work backwards to figure out what you need to do to paint a complete and functional financial picture. Then you can figure out what type of personnel you will need in place by what date to make these dreams come true.
What Qualities Does Your Successor Need?
Remember that whoever you pick to run your business, it is impossible for that person to walk the same path you walked. You don’t need to look for someone who had the same skillset as you. If you built a $100 million company, you need someone who is good at running and growing your business, which is a different skill set than what it might have taken you to build your business from scratch.
McLemore says to consider an interim leader who can do process optimization and who can coach your successor so that in five years, he or she is ready to take over. He emphasizes that in some cases, the founder is not the best person to train the successor. Calling someone with a different skill set to train a successor might be a smart strategy.
Appoint a Disinterested Board of Advisors
McLemore encourages you to diversify the types of people you get advice from. While it may be obvious that you need employees, family, lawyers, accountants, and bankers around you to make a succession plan successful, you also need disinterested input. He notes that your family and paid advisors have a vested interest in your company. You also need a board of advisors that is disinterested in a specific outcome who can make wise decisions that won’t impact them personally. This allows you to get unbiased advice. McLemore says a good strategy is to select a board to accomplish that with a balance of ideas, feedback and support to walk you through a once-in-a-lifetime process.
Business Succession Planning Options
There are some goals that tend to be common to business owners, such as maintaining control of the succession plan, maintaining an income for a comfortable retirement lifestyle, and estate planning for those who have children. Some business owners want to leave a legacy and would like some level of continuity to make sure the business survives the next generation. Other business owners just want to sell the business with more focus on profit and without the desire to control what happens to the business after they leave.
Eric Metzger, Vice President Wealth Planner, Fifth Third Bank says that It’s important to consider the tax implications for each of the different options when it comes to selling your business. Each type of sale offers a unique set of complications, options, and short- and long-term financial factors that you should consider before making a decision.
Metzger says selling to an external buyer, such as a strategic buyer or a private equity firm, will most likely come with cash at closing; whereas selling your business to an internal buyer such as family or an employee might come with financing issues.
However, if you are more concerned with preserving your business’s brand identity, selling to an internal buyer like family, employees, or a co-owner might be the way to go. With an outside buyer, continuity may be lost, as the acquirer may not want key employees to stay.
If the buyer is a co-owner, Metzger says it’s important to have a buy-sell agreement in place. This agreement will specify whether the sale will occur at a specific date, at the time of death, or whichever comes first. The agreement can stipulate a legal obligation to sell or buy to who, when, and for how much. This agreement can help protect surviving owners from not having a succession/ownership plan in place in the case of premature death and can provide for life insurance liquidity at death.
When creating your succession plan, another consideration to include is the amount of capital gains tax you will have to pay on the proceeds of different types of sales. Before the transition plan is chosen and established, it’s a good idea to have a formal valuation of your business done by a qualified business appraiser. The IRS will assign a fair market value to your business; you or the buyer can be subject to extra taxes if the purchase price is far off the fair market value. To complicate things further, Metzger says the true value of your business might differ depending on the buyer.
All of these options for selling your business have different impacts on the owner’s financials. “It’s not an overnight process,” says Metzger of succession planning. He advises all business owners to start thinking about the best way to do the transition and to evaluate how each option can differently impact your financials and income taxes well in advance of when you plan on leaving your business.
To make smart business decisions in succession planning, “It takes a team of advisors, so don’t be afraid to involve those people,” says Troy Farmer, Regional Director of Wealth and Planning, Fifth Third Bank.