Succession planning involves replacing the current owner in the business using a well-thought-out plan, so that the business can successfully operate without interruption. If done well, this process will produce a capable and engaged successor and management team who have been sufficiently groomed and mentored, and who are responsible for the overall operation of the business. Choosing a successor and developing his or her leadership skills requires ample time, effort, and tools in order to make the transition a successful one.
Let’s look at some of the critical elements that should be part of any succession planning process. (Please also see How to Sell Your Business Internally.)
Outline a Plan to Develop the Successors’ Skills – Grooming the successor(s) in a small or family business is something that takes careful planning in order to be successful. Owners should consider working closely with successors and an objective third party to determine:
- The scope and timing for their education or training.
- What performance measures will be put in place.
- How and when the performance evaluation process will take place.
A successor should be placed in a responsible position in the business and have specific and measurable objectives. They should be educated in decision-making, leadership, risk management, dealing with people (including management, employees, and customers), and handling stress – all while being evaluated along the way. As the successor moves through each phase, his or her responsibility should be increased as training and business goals are met and more rigorous goals are established.
Consider Outside Education – It may be a good idea for the successor to obtain some type of outside formal education in order to help him or her learn how to manage the business. Courses in areas such as business management, accounting, business law, and other topics related to the successor’s role may be beneficial. Another idea would be to have the successor join a CEO group or forum in order to learn from other experienced business leaders.
Make Introductions to Outside Contacts – It is likely that the business owner drew on a number of outside individuals to grow his or her business over the years. Once identified, successors should be introduced to the owner’s network of business contacts outside the business. These contacts could include business associates, customers, bankers, accountants, and lawyers. This will give the contacts time to get to know the successor and enable the successor to understand how important these relationships are for the business.
Bring in Outside Advisors as Necessary – It may be beneficial to work with an outside advisor or group of advisors to assist with the succession planning and education of the successor. While the business owner knows what goes into the day-to-day and long-term management of the company, sometimes it can be difficult to see all of the necessary components that need to go into the education of a successor. An outside advisor or advisory board can offer an unbiased view to help the successor achieve their goals and ensure a smooth transition process for the current owner.
Having a sound succession plan in place can help ease the transition for both you and your successor. Developing a plan will allow you to maintain control over this process, have the information you need to make decisions when necessary, and positively impact the outcome for everyone.
To learn more, please listen to our webinar, "A Successful Handoff Is a Balancing Act" with special guest Beth Davis, a leadership and management expert and Principal of Planning What’s Next, a Boston-based firm that specializes in providing succession planning services to business owners and their successors.Read More
Ownership transition is the process of selling or transferring the legal ownership of a business from the current owner to the new owner(s). Business succession is the process of transferring leadership from the current CEO to a family member or key employee. Choosing the right successor is probably the most important decision for any internal transition since the company’s future viability and therefore the current owner’s future payments are dependent on the new leader. Let’s look at some of the most important things an owner will need to consider as they look to transition the business internally and begin grooming a successor.
Who Should You Choose?
When making the decision about who is going to take over, you must consider their capabilities, skills, and desire to become the new owner. The person you’ve chosen may have difficulty wrapping their brain around the prospect of taking over. It’s a lot to take in, and not everyone has the entrepreneurial spirit, the talent, or is in the right life situation to run a business. It’s important to pick someone who thinks like an entrepreneur and has the experience, and confidence to run the business.
Often, in family-held businesses, it is assumed that a family member should be the new CEO just because he or she is family, but a family member isn’t always an option or the best choice. You also can’t assume your key employee wants to take on the risk of owning and running the business. In the case of family members, adult children in the business often feel a sense of obligation to take over the business because they don’t want to disappoint people, but may not truly want to be the new owner. They may feel incapable or just don’t want to bear the burden of business ownership. It’s best to have open and candid conversations upfront and early – well before you plan to exit the business – to avoid any surprises.
Using Objective Criteria to Choose Your Successor
In order to select the correct successor, you must be objective in assessing the candidate’s abilities, attitude, aptitude, and willingness to take on the new role. Identifying the right person is a process that requires careful thought and planning. Here are some things that owners should do when considering their successors:
- Identify potential candidates
- Determine the interest level of those candidates you deem suitable
- Establish measurable criteria for assessing potential successors
- Evaluate the candidates to identify gaps in their skills and experience
- Create and implement leadership development plans for the top candidates
- Monitor the candidates’ progress on these plans
Identifying a successor’s strengths, weaknesses, and abilities is key. You want to make sure they are prepared to run the business to ensure continued success of the company.
The Importance of Succession and Leadership Training
The successor will need sufficient time and training to achieve success in the new role. The CEO role may require different skills and abilities than the person has been using in his or her current role. Don’t make the assumption that since the individual has been with the company for a long time he or she can just move into this role without proper training and assistance.
Transitioning the leadership of a business is an enormous event for an owner, his/her successor, and the business. Change is not easy, but planning can lessen the pain. In small and family businesses, succession planning may also involve a lot of emotional turmoil, and it may be helpful to turn to an outside, impartial group of advisors to help navigate the process.
Don’t underestimate the human element and how much time and effort will be required to make this happen. Developing ownership transition and succession plans are key elements of successful internal transitions; they will not only provide you with the roadmap you need to achieve your own goals, but will provide a concrete plan for business continuity with the next generation of company leaders.
To learn more, watch our webinar, "A Successful Handoff Is a Balancing Act" with special guest Beth Davis, a leadership and management expert and Principal of Planning What’s Next, a Boston-based firm that specializes in providing coaching services to business owners and their successors.
There can be many advantages to selling a business internally, but there can also be some challenges. One of the main challenges is maintaining objectivity about the situation, including your potential successor’s capabilities and whether they align with the needs of the company.
If you plan to sell your business internally, make sure that you take the time to properly evaluate your potential successor(s) and develop his or her business and leadership skills well in advance of when he or she will actually take over the business. Some managers are fit for future leadership, and possibly ownership, while others are not. Going from an employee to an owner is an interesting and tricky process that can be a challenge even for the most skilled manager.Read More
“While 54% of business owners plan to leave their businesses in the next 10 years, 72% [of those] have taken no exit planning action,”* according to a recent study. For most business owners, their business is by far their largest asset, and not properly planning for its transfer can put them, and their employees and family members at risk. Being prepared is the key to success. It starts with educating yourself about your exit planning options, allowing enough time to plan, seeking the best advice, and creating a Business Ownership Transition Plan (BOTP). A BOTP is a comprehensive written document that outlines how and when the ownership of a business will be transferred to others, either internally or externally, in order to achieve your long-term financial and personal goals.
Here are some of the steps business owners need to take to get started.
- Start well in advance. It takes a lot more time than you may think to exit your business, especially if you have to groom your successor or increase the company’s value so you may net enough money from the transition to fund your lifestyle goals.
- Identify and outline your personal goals and what the ideal transition would look like. You may have sacrificed your personal passions and interests in order to devote all of your time, money, and mindshare to growing your business. Your identity may now be one with your business. It takes time to figure out what you want to do when you don’t have to spend every waking hour at the business. Start this process by taking regular time away from the business as you inch closer toward the ownership transition.
This will provide you with some emotional space to reconnect with the world outside, think about how you want to spend the rest of your life, and begin to understand the characteristics of your ideal exit plan.
- Calculate how much money you will need from the sale of your business. As we discuss in our book Cashing Out of Your Business, many owners don’t save much money outside of their businesses. However, this is critical to diversifying your holdings and reducing your financial risk. Taking stock of your assets and knowing the value of your business will allow you to understand just how dependent you are on your business. And by analyzing your personal income needs, you will be able to quantify just how much money you will need to net from the sale of your business.
- Understand the implications of deal structure and taxes. The vast majority of owners know very little about taxes, depending on their CPA to minimize their taxes every year. When it comes to selling your business, however, we recommend that you get at least two knowledgeable advisors to weigh in on the financial implications of your deal structure and taxes. There are various options, and the tax ramifications can be dramatically different. Other considerations when you pick a structure include your desired timeframe, level of control, involvement, and liability during the sale of your business. For example, some structures involve losing control on closing day, while others allow you to maintain control until you collect your last dollar of the sale price.
- Consider working with an objective advisor. There are a lot of moving parts to planning the sale of your business. An independent and objective advisor, who is trained in ownership transition planning, can guide you through the process and help you to understand all the decisions that will need to be made. Most owners will run only one business in their lifetime, and that business is their ticket to financial independence. You may only have one chance at getting this right. There is no downside to planning and a tremendous upside to being prepared.
- Create a holistic exit plan or Business Ownership Transition Plan. The best way to maximize your business value, as well as increase the likelihood for a successful ownership transition, is to be prepared. When done correctly, exit planning aligns your goals and objectives with the best sale or transfer options available and provides a comprehensive roadmap to a successful outcome. This cannot be achieved by addressing revenues or profits alone, and it is not something achieved through luck or chance. It is achieved through careful planning and preparation well in advance.
As a business owner, you are unique – your situation, circumstances, challenges, goals, and objectives are all specific to you. That’s why when it’s time to transfer the ownership of your business to someone else, the exit planning process should take all of this into account.
*Source: Securian Financial Group
Selling or transferring your business internally rather than externally generally offers a distinct advantage: you already have an identified buyer or successor with a working knowledge of the business and an interest in acquiring it.
Since an internal buyer has probably been involved with the business for a substantial period of time and is most often a key manager, family member, or co-owner, he or she has helped shape its culture and position within the community.
In an internal sale, the owner often has the flexibility to remain as involved as he or she desires, which provides time for the new owner to adjust to a new role and receive mentoring and support from the former owner. This can provide the business with a greater chance of continuity and success beyond the transition.
This option provides some great advantages over an external sale, but still requires advance planning and preparation, such as identifying and preparing a successor and being sure the business and owner are ready for the pending transition. There are many decisions to be made.
14 Key Elements to Consider When Planning For a Successful Internal Business Transfer:
- Financial Structure – The internal sale of a business is usually funded via seller financing, the profits of the business, or in the case of a leveraged buy-out, third-party financing. Generally, in an internal sale, the seller does not receive a large amount of cash up front, but down payments can be required.
- Value Used for Transfer – Owners may sell their shares internally at market value if the financing and business cash flow are sufficient. However, some internal transfers are governed by strict IRS guidelines, such as Employee Stock Ownership Plans and gifting, so fair market value (FMV) must be used. FMV is usually less than market value.
- Percentage of Business Typically Sold – Internal transfer options generally allow for a more flexible transfer structure than their external counterparts, offering sellers the ability to sell a small percentage of their ownership up to and including 100% all at once or over time.
- Owner Perks – Depending on the time and percentage of ownership sold or transferred, the perks to an owner can continue during a sale period and be phased out over time. This provides great flexibility to an owner for the continuation of his or her existing benefits.
- Owner Income Stream – The internal sale option provides the most flexibility and possible continuity for income to the owner. An owner can choose to remain involved on a part or full-time basis during the transition and may be able to share in the increase in business value as well.
- Typical Tax Treatment – Some internal transfer options, such as the Employee Stock Ownership Plan, can provide dramatic tax savings. Through proper planning, other forms of internal transfers can be optimized to limit the ordinary income tax and receive the more favorable capital gains tax treatment.
- Fees – With the exception of the ESOP, which can have substantial fees due to its complex nature and IRS requirements, most internal transfer options do not have substantial fees associated with them. The majority of the fees incurred will be legal, accounting, and consulting in nature. Rarely will brokerage or sell side fees be incurred in these types of transfers since the buyer is already identified.
- Preservation of Legacy – The preservation of legacy and the continued employment of current employees and management is generally under the seller’s control in an internal sale.
- Operational Control – Operational control of the business will normally continue until the exiting owner is ready to hand over the reins and the successor is ready to take charge. In the case of an Employee Stock Ownership Plan or a stock redemption plan, the owner can maintain complete legal control over the business for many years, if structured correctly.
- Level of Seller Involvement – Seller involvement can vary and is at the discretion of the owner. Most sellers taper down their involvement over time so it does not negatively impact the business.
- Due Diligence – Due diligence is usually limited since the incoming buyer is very familiar with the business and most likely has been involved with the company in a senior position for quite some time.
- Degree of Difficulty of Transition – The internal sale can be a bit easier to accomplish than an external sale but a strong management team must be in place. Planning for the training, education, and development of new leaders takes time and effort. Adequately assessing the skills, abilities, talents, and desires of the incoming team, are critical to the continued success of the company.
- Disruption to the Company – The internal sale generally creates the least disruption to the company, typically appearing as a rather seamless occurrence to employees. The culture of the company is generally maintained.
- Impact on Employee Morale –The internal sale can produce a positive impact on employee morale. Employees who might have been fearful for their future when employed by a company owned by an aging owner can now be reassured of business continuity. Top-level management is generally involved in an internal sale, and their new leadership role can reenergize a company.
As you can see, there are lots of considerations with an internal transfer and the best strategy needs to be identified in order to achieve the owner’s goals and objectives. Therefore, we recommend you begin this process 3 to 5 years in advance of your desired transition date.
Additional Resources for Selling Your Business Internally
You can download our free guide to help you prepare for a successful internal ownership transition: How to Sell Your Business Internally.Read More
Many business owners want to transition their businesses to key employees or to family members. If the owners are fortunate, there are qualified successors eager to take the reins and ensure that the business continues well into the future.