Why Is a Business Succession Plan Important?
A business succession plan details how a business will pass from your ownership or leadership to someone else when you move on, retire, become incapacitated, or die. The plan provides the structure the sole owners and partners need to make decisions about the leadership and the value of a company before someone is no longer willing or able to lead.
A business succession plan can help protect a company from a hostile takeover from an outside interest if the loss of an owner leads to cash flow or tax problems a business cannot afford to overcome on its own.
If it is a family business, a savvy succession plan can help avoid income, gift, and inheritance taxes.
If the business is owned by partners, valuations of the company and each partner’s share can be done and updated while all partners are still involved in the business. When one of them is no longer there, most of the difficult work has already been done.
A succession plan also provides an opportunity for business owners to select and train their successors so when they are no longer involved, there is consistency in leadership.
Types of Business Succession
There are three basic ways you can transfer your business ownership to others:
- Sell the business. You can sell it to one or more employees, detailing the price, addressing issues such as the right of first refusal, and describing the process for the sale and distribution of the proceeds from it. Or, you can plan to sell the business to an individual or company not affiliated with your business.
- Pass the business on to an heir. Again, valuation and other issues become important if you are passing it on to one or more heirs. This is especially true if, for example, you are giving the business to one heir but not another one. If you want them each to inherit an equal portion of your estate, all the work you do now will make that division much more seamless.
- Your partners buy your share of the business, and you pass on the sales proceeds to your heirs. This is typically handled through a life insurance policy each partner or the business owns for each partner. The death benefit would provide the funds necessary to buy the departed partner’s share of the business, and the proceeds would become part of the decedent’s estate.
Elements of a Business Succession Plan
Every business succession plan is unique; however, there are five key elements it should address:
- It should name a successor or provide a list of potential successors, along with the reasons they are positioned to assume leadership of the company.
- It should provide a detailed overview of the events which would trigger the succession plan, the steps required for succession, and a timeline for when each step should be taken and completed.
- It should include information regarding the valuation of the business, including the mechanisms used to assign its value at any given time. Obviously, valuation is something that fluctuates; therefore, this should be updated regularly to keep it current.
- It should specify how the succession will be funded, whether by life insurance or a seller note to cover any gap between the purchase price and the amount the successor can secure for financing based on the assets of the business.
- It should also cover all operating procedures. This would include employee handbooks, training manuals, quality manuals, and any other documents related to the policies and procedures of the business.