Succession Planning for Small Businesses
Few businesses address the steps necessary to undertake effective succession planning for a multi-generational business to flourish. Learn more about this vital aspect of
While many of us have our personal estate planning affairs in order,
Small businesses and partnerships, especially those without formal governing documents, are particularly susceptible to failure when an owner retires, becomes disabled or passes away. Statistics show that only about a third of family-run, small businesses successfully transfer to a second generation. For this reason, a viable succession plan is vital for any small business owner who intends to pass on her business to a family member or other qualified individual.
A successful succession plan requires not only early
Formulating an Appropriate Succession Plan
While each business owner may approach succession planning slightly differently, there are, however, some basic steps that are common to all successful succession plans. They include:
Selecting a Successor: Small,
Formal Training of the Selected Successor: The chosen successor must be thoroughly trained in all critical aspects of the business. Having a cursory understanding or being proficient solely in the administrative duties is not sufficient and can have disastrous consequences. Therefore, it is imperative that the current owner establishes a formalized training of all critical functions of the business and then have the selected successor actively work in each of these areas until fully trained.
Establish a Schedule: It is imperative to determine when control of your small business will ultimately shift to the selected successor. This avoids the inclination to put off the inevitable and allows both the owner and the successor to naturally transition into their respective roles.
Retirement Planning: While this may be more personal to the small business owner herself and seemingly unrelated to the business, it is an important step in preparing for the transition and planning the next stage of life. This also helps facilitate the business ownership transition.
Execution: If all other steps were followed, this should be the easiest of them all! The chances of a successful succession increase when the selected successor is introduced while the owner remains in charge.
Succession Planning Strategies
But exactly how does a small business owner transfer ownership of a business to the selected successor? There are several options for a small business owner to consider:
- A small business owner may sell her interest in the business for cash or some other asset. Many businesses with governing documents allow for owners to sell their interests prior to retirement or anytime prior to death. While this may be an attractive route to those eager to move into retirement, accrual of capital gains taxes and other financial ramifications must be considered.
- A small business owner may also choose to enter into a buy-sell agreement that essentially sets forth the terms of the sale of the business interest ahead of some predetermined event, such as retirement, divorce or death. Such agreements call for the purchaser to pay
fairmarket value of the business at the time of the predetermined event.
- A small business owner may elect to utilize a more complex instrument such as an irrevocable trust that allows the owner to transfer assets while maintaining the flow of income over a certain duration. After the death of the owner, the assets will transfer to other named beneficiaries.
- The small business owner may also sell the business to a purchaser in exchange for ongoing payments for the duration of her life, thereby creating a form of
- Another more sophisticated instrument would be the use of a self-canceling installment note in which the buyer makes a series of payments to the business owner throughout her lifetime.
- For instances when transferring a business to a family member, the owner may use a family limited partnership that allows the owner to gift business interests to family members over a period of time. This, too, is a sophisticated tool and may not be feasible for all small business owners.
The intricacy of a succession plan is dictated by several factors including, but not limited to, the specific retirement needs of the owner, the complexity of the business entity, market value