What is Succession Planning for Entrepreneurs?

The Second Habit of Highly Successful People is to begin with the end in mind.[1] Almost weekly, entrepreneurs, business owners, and professionals talk with us about the goals for their business or practice. Few discuss their expected exit from the business. Practically none of them have thought about what would happen if they couldn’t go into work tomorrow. Indeed, 3 of every 4 companies in the United States do not have a business succession plan.

Entrepreneurship comes with many responsibilities and hurdles. As entrepreneurs, we are on the hunt for the reward of success. We must jump over the hurdles of imposter syndrome, negative self-belief, and most importantly making our business actually work. Unfortunately, we can be so laser focused on achieving success that we forget to consider what happens to our business after we are gone.

If you spend your time building a successful business, you should definitely consider investing some time on planning for its future. Developing your succession plan is a critical element of business planning. Many business owners fail to appreciate the complexities and time involved in successfully transitioning a business. Transitions in a business are prompted by retirement, sudden illness, incapacity, other major life events, or death. Failure to plan for the inevitable situations of life puts a business’s survival at risk.

For example, let’s say that you have spent half of your life building your successful business. Unfortunately, life’s circumstances cause you to become incapacitated. You are the backbone of the company, so this incident has disrupted your company’s key systems as no other individual has the sufficient knowledge or experience to lead in your absence. What will happen to your business? Who makes decisions? A business succession plan addresses these issues by identifying and implementing the strategies necessary to successfully carry forward your vision under new leadership, transfers or appoints new leadership, and can facilitate the proper preparation needed for a smooth transition in the company.

In fact, we learned this somewhat the hard way in our family. When my wife was being treated for breast cancer, her ability to practice decreased. Had she not made the decision to purchase disability insurance, our family would have doubly suffered. At the same time, her colleagues at the practice had to cover her patients when she was out. It wasn’t the best plan, but it got the job done. On a side note, she’s doing extremely well and is cancer-free!

My wife’s situation was the easier of the two. During the course of her treatment, I had to make decisions about the practice because I spent a significant amount of time helping her and attending to other family matters. Life certainly goes on during a time of hardship. Therefore, the succession planning that had not been considered was for my Firm. The lesson here is that a business succession plan might not only affect you, the business owner, but also the people around you.

Additionally, as those in leadership age, they must consider whether they have funded their retirement accounts sufficiently to sustain them when they stop working. Creating a plan can help you secure your retirement. It helps you avoid unnecessary costs of handing over your business and ensures you take advantage of available tax benefits. [Remember – the SECURE Act removed the limit for retirement account contributions.]

To develop a sound plan, you must consider your desired exit strategy. There are several options available that you can discuss with your trusted advisor. Some business owners decide to keep ownership and management within the family. This option is often selected when one desires to nurture specific family values over time. If this situation arises, a transitioning owner should explicitly document and teach these values. Additionally, current leadership should diligently assess which family members have the ability and interest to lead the company. It should be noted that successor decisions can affect internal family dynamics; the choice to transition in this way should not be made without careful deliberation.

Another option is when business owners choose to pass leadership to a key employee who fully grasps the nature of the business. When a company’s leadership opts for this transition strategy, it is important to determine the additional training and development the successor employee may need to usher the company into its next stage. Another important consideration is ensuring that the employee has the financial ability to purchase the business. As the current owner, you may have to assist the employee in securing the financing necessary to buy the business.

A third strategy is to sell the business to a third party. An objective external party may be able to make better decisions regarding the future of the business due to their unbiased point of view. Challenges may arise between the successor and older employees who are not acclimated to the new leadership style, however. This tension could result in high turnover during the transition period, but with proper preparation and support the new leadership and older staff can adapt successfully.

Finally, business owners can choose to pursue a hybrid option where management is turned over to a key employee while the family retains full or partial ownership. This strategy allows the family to maintain financial rights as well as top-level decision-making power, while simultaneously preserving the most qualified candidates to manage the business.

Each of these options presents its own benefits and challenges but in order for them to work, they must be planned for. Early analysis of these various options will allow owners the time needed to prepare their successors.

Below are a few other points that must be considered when preparing a business succession plan:

  • Taxes – The various successor options may lead to different taxation issues. One should consult a tax professional to explore the estate, gift, income, and sales tax implications of the transition.
  • Valuation – In any business succession, it is important to identify how much the business is worth and the practical implications of that valuation. The valuation will not only have tax consequences but also affect negotiations when it comes to the transfer of ownership. There are many different ways to value a business and sometimes, the IRS will not follow the value the business determined, but will instead make its own determination – and will adjust taxes accordingly.
  • Insurance – Business succession planning is often accompanied by insurance planning to ensure that the cash necessary for the plan is available. Business owners may seek life insurance, disability insurance, and key person insurance to fund transitions and keep businesses afloat during death or disability—the more unexpected life events that often trigger these transitions.

We Can Help

The best time to begin succession planning is now. Navigating the legal implications of business transitions can be complicated, but we are here to help. Call our office to schedule your initial consultation. Our team is ready to provide sound advice and legal solutions to facilitate a successful transition.

[1] Covey, Stephen, The Seven Habits of Highly Effective People, 15th ed. (2013).