Owners of family or middle-market businesses invest a tremendous amount of time and energy — sometimes their entire adult lives — building a successful business. Yet they often spend little time working on their succession plan.
“The business world is littered with second and third generations that don’t succeed in continuing the business,” says Jay Silverstein, principal in the Wealth Services Group at Moss Adams LLP. “One of the big reasons is that there wasn’t a well thought-out succession plan.”
Smart Business spoke with Silverstein about why it’s important to implement and continually monitor a succession plan.
Does every business need a succession plan?
Any business owner needs a succession plan. But the plan may differ for a business in the start-up and growth mode where the owner is not looking to exit the business compared to a mature business with an owner looking to retire in the near future.
In earlier growth stages, a succession plan is a contingency that allows the business to sustain itself if something catastrophic happens. In many cases, banks that lend to closely held companies require this type of management succession planning. They want to know the business will continue to be profitable and be able to pay off the loan if you’re not around.
Where should you start?
You need to identify and prioritize your goals and objectives in three separate areas: personal, business and family.
You and your advisers should complete a personal financial plan to understand your post-transition cash flow needs, and the likely sources of that cash. Do you need to sell the business or have you accumulated outside assets? This is important for an owner who must figure out how to increase the business’s value to be able to retire, as well as someone whose net worth is higher than his or her need. If a sale will generate more cash than you’d need, estate and gift planning decisions should be made prior to a liquidity event to help minimize tax obligations.
Consider what you want to happen to the business. Will it continue as a family legacy or do you want to sell it? These decisions help determine an appropriate exit strategy and limit your succession planning options.
Finally, what do you want for your family? With a family business, what do you deem to be fair and equitable in terms of transitioning to the next generation?
What else do you need to address with a family-owned business?
If the goal is to preserve the business into future generations and your objective is to be fair and equitable to all, it’s critical to work through a detailed succession plan well in advance. Is it possible to get business assets to the heirs who are involved in the business, and equivalent assets to those who aren’t? If not, you must strive to create an ownership structure that doesn’t drive a wedge between your heirs.
Do your heirs even want to run the family business? If they are already involved, take an independent look at whether they have the attributes and skills to take over. If so, they still may need additional training under a management development plan.
What common mistakes do you see?
With family businesses, some people gift ownership to their heirs before implementing a succession plan. Then, brothers and sisters who are never going to work in the business are wondering when they can turn their ownership into cash. You also don’t want to have heirs come to work in the business without clear rules of entry and how to move up in the company.
If you’re going to sell, you may think you don’t need succession planning. However, you still must examine what sale price you need and your estate tax situation, so you can deal with income tax structure issues and improve the company’s value.
You need to dedicate enough time, enough in advance, to meet goals and objectives. Succession planning doesn’t give you an immediate ROI and there’s no guarantee of success, but it gives a far better opportunity of preserving what you’ve created.
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