Selecting the right successor is a critical decision that can significantly impact the future of the business you spent your life building. The next in line should have passion for the work, be a respected member of the company and the industry, and have the expertise needed to lead the company into the future.
Ask yourself: Can your chosen successor make the tough decisions that you, as the current owner, may have grappled with in the past?
Considering only 30% of family-owned businesses survive the second generation, this a question that business owners should spend time reflecting upon. Many businesses that fail after the founder steps down do so because of the lack of a succession plan. According to the Exit Planning Institute, 78% of businesses have no transition team, and 83% have no written transition plan.
An effective succession plan not only ensures the continuity of the business but also includes the transition plan of the owner stepping away and giving control to a named successor with the resources and knowledge to lead the business.
Finding the Right Successor
Before beginning the selection process, it is important to take a step back and analyze your own role, taking into account crucial aspects of running the business and what skills will be necessary to take the company to the next level.
Often, company owners have a desire to keep the business within the family by passing it down to a child or other family member. However, this might not always be the right choice. A strong succession plan defines the successor’s qualities and responsibilities to ensure the best candidate is chosen. The children might not always possess the business qualities desired, leaving the founder with no choice but to look outside the family. Evaluating the existing skills and identifying areas for development in each candidate enables a targeted growth process to prepare them adequately.
Grooming the new leader years in advance is key to a successful transition, involving formal management training, incremental responsibilities, and client interactions. Even if family, internal, or external candidates are not viable, planning for a potential sale well in advance is crucial.
A Smooth Transition
A successful transition plan creates a structure the business can follow throughout the transition. A mission statement creates a starting point that centers all participants and includes the company’s core values, goals for the transition, and lays out the responsibilities. Aligning the company’s values with the succession plan leads to a meaningful exit.
Succession plans are quite comprehensive and include a number of key players, including attorneys, CPAs, financial advisers, and insurance experts. When the family is involved, a family dynamics professional may be helpful to ensure alignment.
Another critical component of a succession plan is the retention of key employees. How does your company ensure “business as usual” once the transition occurs? Employment agreements, stock option plans, and other incentives may ensure your most valued employees stay with the company after the transition.
Finally, a good succession plan weighs tax implications. For example, owners concerned about estate taxes can consider gifting the business before retirement to lower the size of their taxable estate. When estate taxes are not a concern, transferring ownership after death allows heirs to receive a step-up basis and pay fewer capital gains down the line versus receiving the business during the original owner’s lifetime. An experienced team can help the owner navigate these tricky waters, setting the stage for a smooth transition.
Structures to Minimize Transfer and Estate Taxes
There are many structures to consider when transitioning the business to family members or another successor. A few include a 1031 Exchange, a Grantor Retained Annuity Trust, Irrevocable Trusts, or a Limited Liability Company.
When leaving a company to heirs, the Family Limited Partnership (FLP) is another structure to consider. An FLP can facilitate the business succession and potentially save money on taxes. With this structure, each family member owns shares and has voting rights in proportion to their holdings.
Owners can transfer shares to the next generation at discounted values while maintaining business control. This, in turn, makes the FLP a viable method when business ownership will be transferred over several years. As a result, the new owner(s) can see reduced estate taxes up to 20% to 50% under its pre-FLP value. Additionally, income shifts to lower brackets, creating a tax-efficient transfer.
Leaving More Than Your Legacy
A comprehensive succession plan outlines the responsibilities and manages expectations for all parties involved, setting the business up for success once the baton is passed on. A strong succession plan takes years to prepare and implement, so don’t wait. Form your panel of experts and begin identifying the right candidate(s) to lead the company into the future. This will help avoid any major disruptions that can create problems with revenue streams, client retention, or other internal conflicts. A business’ key differentiator will always be talent, so investing time and resources into retaining key employees will only prove beneficial to build your business a better tomorrow.
Don’t wait. Take the steps now to build a succession plan that will set the business, your family and the successor up for success.