You’ve imagined what your last day in the office will look like, haven’t you?
Passing the baton to those you’ve groomed, enjoying the fruits of a career dedicated to the business you’ve built, riding off into the sunset, perhaps literally, to travel and unwind.
It sounds beautiful and glorious.
Now, what have you done to actually prepare for that day (outside of imagining it)?
If the answer is not much, I have some unfortunate news. That day you imagined? You might need to push it back a couple of years.
The hard fact is that succession planning in your small business can’t happen overnight. You will need to craft a coherent strategy to hit on multiple dimensions, from managing your personal and family goals to retaining and growing top talent to navigating tax and legal exit considerations.
Don’t let a lifetime of sweat equity evaporate by improperly preparing your business for your exit. Start the process of succession planning today to secure your retirement, create a sustainable firm for your employees, and preserve your professional legacy.
The Need for Early Succession Planning in Your Small Business
Small business owners face a bevy of complexities when planning for their eventual exit from the business. Some owners may want to ensure the long-term success of business operations while others may prefer to maximize their family wealth through extensive (and complicated) financial and legal planning. The waters become further muddied when family issues are introduced, like leaving a legacy, considering birthrights, and managing personalities and interpersonal dynamics.
Even if those important to the process recognize the need for succession planning, the burgeoning quagmire of issues often prevents implementation. How do you start? Who do you call (not Ghostbusters)? Are you being fair to your family, your internal stakeholders, and your potential successors? Do you have the time to extricate yourself from the day-to-day in order to focus on long-term planning?
This list of questions, far from complete, is a major reason why so few firms have an actionable succession plan in place. A Wilmington Trust survey found nearly 60 percent of small business owners do not have a succession plan in place. Though difficult, coming up with the list of questions specific to your family and firm, and at least reasoning through your answers, is a critical first step.
You will also need to account for your firm’s strategic direction when building a succession plan. This is the proverbial “skate to where the puck is going” statement, put into action. Hopefully you have separately implemented a strategic planning process within your firm. Now, you will need to add another succession planning layer.
This means your succession planning is more than just a review of your firm’s org chart — you will have to consider how the organization’s operating structure will evolve over time. What new growth areas are you pursuing? How will you support these new initiatives? How are workflows managed today versus in the future? Answering these questions allows your succession planning process to support the dynamism inherent in your firm and your industry.
Finally, and this lesson seemingly applies to every aspect of our lives, but consistent and clear communication is key. You likely have your own goals, for your exit as well as the trajectory of the business, but there are internal stakeholders with their own needs and concerns. Including stakeholders in the firm’s goal-setting process can empower those who will step into your shoes and set the stage for a smooth transition.
Financial Foundations of Succession Planning
Succession planning involves more than just deciding who will run the business. Equally as important is determining what kind of business those successors will run. Plus, understanding the enterprise value of the firm and funding the ownership transition go hand-in-hand with these strategic decisions.
While your existing entity structure (be it sole proprietorship or closed partnership) may have served your needs as owner, this may not be necessarily true for the next generation of ownership. Liability exposure, access to capital, and the personal financial needs of both the owner and other internal stakeholders complicate the entity structure decision.
While a full discussion of all entity structures is beyond the scope of this blog post, each type offers different benefits, issues, and costs that will change the complexity of your succession planning process. Speak with your legal, tax, or financial advisor to determine if a limited liability company (LLC), partnership, S corporation, or C corporation designation would be the best fit for your firm.
What’s your business worth? The value of your business will have an enormous impact on many different succession planning issues, from taxes and estate planning to exit funding to shareholder agreements.
You likely have a number in mind, but we’d caution against focusing on this unverified figure when building your succession plan. And while determining the value of your firm isn’t as easy as looking up the Kelley Blue Book value of your car, there are three generally accepted ways to describe the value of a business: fair market value, investment value, and liquidation value.
The fair market value of your firm is the theoretical price one would pay based on supply and demand for the business. Fair market value assumes that all of the parties involved are acting freely, impartial and without compulsion. Investment value varies considerably since the value is based on a potential buyer’s investment requirements and expectations. Liquidation value is the value of the firm based on the value of saleable assets. Liquidation timing also plays a role in the overall valuation. For example, a forced, immediate liquidation will reduce the expected value of the business since there isn’t time to shop the assets to multiple potential buyers.
Generally speaking, there are three methods to calculate the value of your firm. The income-based approach estimates the value of your business’s operations based on the present value of expected future cash flows or operating income. The market-based approach estimates the value of your firm by comparing it to the price of similar (and ideally, recently sold) companies. Since the market for small businesses isn’t as deep as the market for public securities, valuation professionals often turn to market-based multiples and adjust them based on differences in the risk and growth potential of the firms. The cost-based approach estimates value based on the fair market value of a company’s assets minus the fair market value of its liabilities.
Talent and Leadership Development
Success in succession planning comes down to your successors. Sounds like a Yogi-ism but there is truth in that tongue-in-cheek statement.
A family-owned business often takes a more informal approach to succession planning, with the founder relying on one-on-one interactions to find and train a successor. Of course, family dynamics, including birthright issues, can play a big part in this process. While this approach may work for a very small firm, it quickly breaks down when your business is planning growth initiatives that may outlast your remaining time at the firm. We recommend incorporating a process that determines what leadership demand your business will need, what talent exists within the firm (and potentially, identifying outside resources), and implementing a program to develop the leaders you will need in the future.
Succession planning is much more than just the woman or man who will take the top job upon your exit. It extends throughout your organization, and dynamically changes based on the growth path of your firm. And yes, while your shoes will need to be filled, what happens to that person’s existing responsibilities? And the person who replaces that person? What about that new division you think will really drive growth in the next five years — do you put your top executive there or do you keep them on your executive bench to oversee its integration with the rest of the business? Identifying the demand for leadership and management positions, both today and in the future, is a necessary exercise to ensure a seamless transition.
Now that you have a better idea of the leadership positions you will need, up and down the firm, you have to evaluate who may be able to slot into those roles. This means evaluation of your existing staff, in terms of their current performance and their future potential. We recommend taking a dispassionate approach (and NOT ranking via beans). You may be surprised to find out that a high performer is best suited to remain in a technical role and not transition into leadership, or that a key player needs additional training to make the leadership leap you envision.
How do you do that? Give potential leaders stretch assignments and rotate them across different divisions, if possible, to expand their current skill set. Provide mentoring and executive training opportunities. And align compensation with expectations on performance.
Speaking about compensation a bit more, consider a “total rewards” approach. A total rewards approach includes opportunities for personal development and opportunities for long-term professional growth, in addition to the standard methods of compensation via salary, bonus, and other monetary awards. Tying together long-term incentive compensation (to retain talent) with short-term incentive compensation (to fully participate in the succession planning process) is a power combination to achieve your succession planning goals.
Small Business Planning with Harbor Crest Wealth Advisors
Though succession planning seems like an arduous process, it doesn’t have to be when you define your goals and needs and empower internal stakeholders to participate in the transition. We can assist you in the process so you can secure your retirement, create a sustainable firm for your employees, and preserve your professional legacy.
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