You have built your business from the ground up, and in a way, it has become a part of who you are. It’s your baby. You have poured countless hours into the management and operations, hiring, accounting, payroll, advertising, and making tough decisions. Now, you have endured Covid-19, and you are proud of what you have accomplished.
After working for years to build a successful business enterprise, you are now starting to think about your golden years and how you would like to spend them. After much deliberation, you are beginning to see retirement is the next step for you. This has you thinking, “but what do I do with this business I have poured my life into?” At DHJJ, we know this can be an exciting and scary time, and we are here to help you walk through this life-changing season. To maximize the value of your business and properly sell or pass it along to the next generation, a succession plan should be in place.
Perhaps you have heard of succession planning before, or maybe this is the first time you have heard of this concept. Either way, business succession planning is essentially the process by which you, as a business owner, begin to plan for another person to either buy or operate your business once you have retired. Business succession planning may also be helpful if you should ever become disabled or pass away. In summary, business succession planning is the process of handing your business operations to another.[1]
In the content below, we discuss the basics of succession planning for business owners hoping for a successful transfer.
What are the Benefits of Succession Planning?
As with any planning device, there are probably business owners you have known who did not use a specific business succession plan, per se. However, there are many benefits to succession planning for your business. For example, a succession plan is a great resource to ensure your staff will continue with your specific strategic vision by providing a plan to communicate your vision with your current staff that will be passed along to future staffers. These plans can also encourage your staff and build leadership qualities in them. Finally, a succession plan gives your successors the tools to actually “do” your job when you are no longer easily accessible to train them.[2]
If your business is a limited liability company, a corporation, or a larger entity, a business succession plan is a great way to give reassurances to members, board members, investors, and others who are interested in your business success.[3]
Why is Business Succession Planning Important?
As mentioned above, determining who will financially and legally take over your business upon retirement, death, or debilitation is no small matter. Even if you do not plan to retire or sell at any time in the near future, having a thorough succession plan in place is vital to ensure success for you, your business, and your successor years down the road. Unfortunately, emergencies do happen, life circumstances change, and dealing with the unexpected begins by preparing for the future now.
According to ForbesFunds, succession planning is:
- A leadership development strategy
- A best practice for sustainability
- A risk management best practice
- Crucial for knowledge transfer
- Not just for the C-Suite
- Not just for when an Executive Director is leaving
Succession planning offers peace of mind for any business owner, regardless of the retirement timetable.
3 Primary Ways to Transfer Ownership
If you have decided to move forward with a business succession plan, then one of the first things you will need to decide is what type of succession you would like your business to have. Although every situation is unique, there are three primary methods of ownership transfer:
- Selling the Company: Are you the sole proprietor of your business, or do you have a partner? If you are a co-owner, you could sell your interest to the company. If you are the sole owner of a business, you may sell your company to an outside party – such as an entrepreneur – or a trustworthy employee.
- Transfer to a Co-Owner: If you do not like the idea of selling your interest to the company for lack of assurance who will end up with the interest, then rather than selling ownership interest back to the company, you may sell your share or interests directly to a co-owner.
- Pass the Company to Someone Outside: You may choose to pass ownership interests along to an heir, such as a family member or some other person or entity.
Once you have determined which transfer option is best for your specific situation, a succession plan can be crafted and tailored for your specific needs.
How Does a Succession Plan Work?
A succession plan is a detailed document intended to provide step-by-step instructions for an ownership change. Every small business succession plan should include a timeline, a list of potential successors, the valuation of your business, a succession funding plan, and standard operation procedures (SOPs).
Your Succession Plan Timeline
Your succession plan should include a detailed list of circumstances and, if applicable, dates for all major steps in the succession plan. Depending on your business and preferences, your timeline may stretch across five years or twenty years.
A List of Potential Successors
Although you may have a single successor in mind, it is best to list multiple options to accommodate a wide variety of possible future scenarios. These potential successors should be organized by order of consideration. If you are not planning to transition soon and do not have a set successor list in mind, begin by listing qualifications, skills, and/or personality traits you would like to find in a future successor.
Your Business Valuation
One practice that will greatly help you in succession planning is to perform a business valuation regularly. This is critical in many situations, whether it is from working with a potential investor to refining an exit strategy plan. Furthermore, your business valuation should remain current. By regularly performing and updating the business valuation section of your succession plan, you position your business to receive a more accurate succession plan with real data.
Depending on the size of your business and the purpose of valuation, different methods may be used.
A few common methods for small-to-medium business valuation include:
- Asset-based valuation: a simple asset-based valuation is determined by adding the value of business assets and subtracting liabilities.
- Capitalization of cash flow (CCF): the capitalization of cash flow valuation method can be calculated by dividing cash flow by a capitalization rate. If one-time expenses or income events occurred during the selected time period, you should make adjustments to remove these events from the cash flows used in the calculation.
- Discounted cash flow (DCF): like CCF, the discounted cash flow method is income-based. However, DCF is often utilized for companies expecting a significant increase or decrease in income within the near future, while CCF is generally utilized for businesses in which the future is expected to be similar to the recent past. To determine current business value, DCF uses projected future cash flow, a discount rate, and the time value of money concept.
- Market-based valuation: this method is relatively straightforward. Market-based valuation looks at current market transactions and estimates value by comparing the subject company to transactions involving similar companies.
- Seller’s discretionary earnings (SDE): for small business valuations only, the seller’s discretionary earnings method is beneficial to estimate how much a future buyer can expect to make from the business. Business earnings before taxes and interest can be added to owner’s compensation and non-essential business expenses to calculate the seller’s discretionary earnings.
Your Succession Funding Plan
You may choose to fund your succession by many avenues. Some of these funding sources include life insurance, external lines of credit, or internal sinking funds. An Employee Stock Ownership Plan (ESOP) is another alternative that works in certain situations. Other funding options require the purchaser to secure their own financing, or negotiate seller-financing terms with you. Regardless of the chosen method, funding methodology will affect price, terms of succession, and responsibilities of buyers and sellers within the agreement.
Standard Operation Procedures (SOPs)
Before transferring ownership, be sure to garner and share a complete collection of formalized SOPs, including essential documents, employee handbooks, taxation forms, and training materials.
Determine if Your Business is Sellable
If you plan to sell your business to an outside organization, determine if your business is profitable within its industry.
- Does your business have a history of profitability? It goes without saying that a financially stable company – with a history of consistent profitability – will be more attractive to potential buyers than a less profitable organization.
- Is your business in an attractive industry? Although there are certainly buyers for niche industries, businesses in attractive industries may have a larger assortment of potential buyers.
- Where is your business located? Consider: Is your business in a highly desirable area for your type of industry? Do you have a consistent customer base? A consistent and diversified customer base can point towards long-term profitability and business value.
- Are your assets in good condition? Assets with market value and remaining useful life assist in business value and potential buyer attraction.
- Do you have a strong balance sheet? Businesses that appear worth purchasing usually have retained earnings, great net worth, and low or nonexistent debt.
Succession planning well in advance of a transition is extraordinarily helpful for correcting any salability issues. If the answer to any of the previous questions is no, a succession plan will show you what to focus on while you have time to make changes. This can help increase your business’ value and increase long-term profitability for future owners.
3 Succession Planning Questions for Every Business Owner
Do you have some ideas in the back of your mind about what the succession plan for your business looks like? Are you hoping that a family member or partner will step into your role? Or have you thought about selling your business someday when you’re ready to retire?
It may seem like these situations are too far off to start thinking about them quite yet—but if the decision involves other people, it may take a considerable amount of time to come to a consensus. Each shareholder will need to determine how long they would like to stay involved with the company and what they want that role to look like, and then adjust their individual plans accordingly. You’ll need to determine the worth of your business and likely have some tough conversations with people who are close to you. It can take years to get the right plan in place.
As difficult as it may seem to broach the topic of succession planning, it’s much better to get everyone’s feelings in the open before it’s too late. We work with a lot of family business owners at DHJJ, and we’ve seen how avoiding the conversation can lead to messy situations with truly unfortunate timing. Our team of advisors has experience with business valuation and accounting across industries like manufacturing, distribution, construction, professional services, and more, and they know the right questions to ask to help you navigate the decision-making process with your family and shareholders.
Succession planning boils down to three basic questions:
1. What is Your Business Worth?
Whether you’re open to selling your business or not, a business valuation is the first step on the way to determining its future. Even if you’re not planning on going anywhere for a long time, doing a valuation now can give us a ballpark idea of what that number might look like when it’s time for your business to change hands. You’ll be able to make better decisions when you know exactly what your business is worth and what factors might have a significant effect on that value in the future.
You’ll need to gather documents such as tax forms, income, output, loans, liens, and market data to get started with a valuation. Once we’ve determined the health of your business, identified its strengths and weaknesses, and made some key projections, we can make an accurate estimate of the company’s overall worth.
2. What Do Other Stakeholders Want?
How many people depend on your business to make a living, and are there other leaders on your team who have their own ideas about where the company is headed? And what about your spouse and children? Some people build a family business with the expectation that one of their relatives will take it over when the time comes—only to find out that their son or daughter has different dreams. When two or more people have different ideas about who’s in charge, arguments can erupt. But that doesn’t have to be the case!
Succession planning is about assessing where everyone stands and putting measures in place to avoid these conflicts before they happen. When you dig into the numbers and start to explore the potential tax impact of your various options, you might find that things are different than they appear on the surface.
3. What’s Your Exit Plan?
What’s your vision for how you want to spend your golden years? Do you love your job so much that you want to work until the very end, or do you want to hire a CEO to keep things running while you enjoy life in a warmer climate? Or is selling your business an option for you? Will you need to set up a family trust? Once you clarify what you want your future to look like and share that plan with a trusted DHJJ Advisor, you can outline the best-case scenario for your business and your retirement together.
We’ve been in business for 48 years, and with a team of over 100 people, we cover a deep and wide scope of services. Our team of Exit Planning Advisors has skills ranging from business valuation to value-enhancement consulting, mergers and acquisitions, litigation support, and state and local tax planning strategy. We even do family wealth management and retirement planning.
Putting off these important considerations until someday when you need the answers can ultimately limit the growth of your business and result in less wealth passed down to the next generation. Work with a DHJJ advisor to ensure that no opportunities are missed and that your family is still getting along when it’s time to hand off your business!
So what comes next for your business, your shareholders, your loved ones, and your retirement? Get in touch with us and let’s start the conversation today.
DHJJ: Exit Planning Services
Succession planning is not a simple and quick process, and we know this can be overwhelming, so we are committed to helping you. One key way to alleviate some of the stress of formulating a succession plan is by consulting professional advisors to assist in the task is the best method for creating a comprehensive strategy.
At DHJJ, our team of expert advisors customizes our exit planning process based on your unique situation. The succession planning process may include wealth management, tax structuring, mediation, value and profitability enhancement consulting, business valuation, or any collection of succession strategies.
To schedule a consultation with our exit planning team, please contact us at 630.420.1360 – we are excited to guide you through the business succession planning process.
[1] https://www.sba.gov/sites/default/files/files/PARTICIPANT_GUIDE_SELLING_SUCCESSION_PLANNING.pdf
[2] https://forbesfunds.org/wp-content/uploads/2021/01/Roadmap_to_Succession_Planning_PowerPoint.pdf
[3] https://forbesfunds.org/wp-content/uploads/2021/01/Roadmap_to_Succession_Planning_PowerPoint.pdf
