Preparing to Pass Your Business to the Next Generation
The day-to-day demands of running a company can sometimes leave little time for big-picture reflections about the future. While strategic nimbleness allows changes to be made quickly in response to external circumstances, it is also important to set baseline goals and establish a roadmap for the business for the next quarter, the next year, and beyond.
Small business owners know the power of planning. A surprising number of them, however, have no plan for the inevitable day when they step away from their business. Many entrepreneurs give inadequate attention to their talent pipelines and succession processes. Not having a succession plan poses major organizational risks that could ultimately destroy the company.
Succession planning should start, at a bare minimum, five to seven years before the expected transition. But to best prepare for the unexpected, it is important to build a succession plan from the company’s inception.
Failure to Plan: Planning to Fail?
According to the 2023 North America Family Business Report from Brightstar Capital Partners, 9 out of 10 family businesses have no plans to reduce the family’s stake in the business.[1] And the Harvard Business Review says that family businesses tend to outlast the typical company because they care more about leaving a legacy to the next generation than about short-term profits.[2] Failing to plan for leadership succession, though, can derail any company, whether it is a family business or a Fortune 500 firm.
The direct costs of insufficient succession planning include increased spending on recruitment, training, and overtime; loss of business continuity and revenue; excessive leadership turnover; and harm to customer relationships. There are also indirect costs, such as a negative impact on company culture and loss of institutional knowledge.[3]
How to Make a Smooth Ownership Transition
Americans are on the cusp of what is being called “The Greatest Wealth Transfer in History” as baby boomers have begun passing on $30 trillion to younger generations.[4]
Some of this wealth transfer will involve family business ownership interests. Over the next 10–15 years, millions of boomer-owned businesses are expected to change hands.[5]
Having the right people in line to take over at the right time increases the odds that the company will flourish well into the future. This entails having a succession plan and sticking to it. An effective plan should incorporate the following steps:
● Identify positions in need of a successor. This includes not only the owners or founders but also mission-critical positions such as executives, managers, and other key employees.
● Set eligibility requirements and performance expectations. Developing these criteria is integral to filling important positions when they become vacant.
● Build a talent pipeline. Identify internal candidates who meet succession requirements. If none currently exist, outside hires can strengthen the talent pipeline and fill succession gaps.
● Prepare successors to take over. Successor candidates need to be set up to succeed through teaching, mentoring, and compensation incentives.
● Document and regularly evaluate the succession plan. Have policies, procedures, and governance documents that support succession planning and revisit them each year to continually refine and improve the plan.
● Determine what the business is worth. Before business interests can be transferred, the business’s fair market value must be established. A professional appraiser or certified accountant can assist with determining a dollar amount.
Succession Planning Legal Considerations
Common choices for a successor business owner are a co-owner, family member, or key employee. But regardless of whom a business owner chooses to fill their shoes, the decision must be supported by thorough legal preparation.
Here are some legal considerations to keep in mind to ensure a smooth transition:
● How will the business be transferred? There are several options for transferring a business to new owners. Family businesses could gift the company to successor heirs, which has tax and estate planning benefits. They could also implement a partial or complete sale that provides financial assistance to the buyer or place business assets in a family limited partnership or family limited liability company. A sale to business partners typically involves a buy-sell agreement, a cross-purchase agreement, or an entity purchase agreement. And when selling to an outside party, essential documents include a purchase agreement, financial documents, and nondisclosure agreements.
● Does the plan cover the unexpected? Ideally, the current owners will have a succession plan that enables them to step aside at a time of their choosing and ride off into the sunset of retirement—or whatever else comes next. Of course, not everything in business—or in life—goes as planned. That is why a succession plan should incorporate contractual arrangements that address what will occur in the event of other triggering events such as death, disability, divorce, and bankruptcy that can require successors to step in sooner than expected.
● Is everything in writing? It may be tempting to skip due diligence and contractual formalities when transferring business ownership interests to family members. But regardless of the identity of the buyer or the means of transfer, to reduce the likelihood of disputes or even litigation, each step in the business succession process should be put in writing, reviewed by an attorney, and signed by all parties.
Legal Help for Successful Succession Planning
Nobody goes through the rigors of starting and running a business without the hope that it will endure. Entrepreneurs want to build a valuable business that lasts—and that requires more than hard work. It also means having a concrete plan that enables the owner to exit the stage without disrupting the business’s operations.
Relinquishing control of your business can be difficult. But having a succession plan makes it easier, smoother, and more successful for everyone involved. Succession planning should be done early and revisited often with the assistance of a business attorney. To start planning your exit, please contact our office to schedule a meeting.
[1] The North America Family Business Report 2023, Brightstar Cap. Partners, https://brightstarcp.com/family-business-report (last visited May 17, 2024).
[2] Josh Baron & Rob Lachenauer, Do Most Family Businesses Really Fail by the Third Generation?, Harv. Bus. Rev. (July 19, 2021), https://hbr.org/2021/07/do-most-family-businesses-really-fail-by-the-third-generation?registration=success.
[3] Nat’l Insts. of Health, Succession Planning: A Step-by-Step Guide, https://hr.nih.gov/sites/default/files/public/documents/2021-03/Succession_Planning_Step_by_Step_Guide.pdf (last visited May 17, 2024).
[4] Mark Hall, The Greatest Wealth Transfer In History: What’s Happening And What Are The Implications, Forbes (Nov. 11, 2019), https://www.forbes.com/sites/markhall/2019/11/11/the-greatest-wealth-transfer-in-history-whats-happening-and-what-are-the-implications/?sh=466d22d24090.
[5] Baby Boomers: Incredible Numbers are Buying and Selling Businesses, Cal. Ass’n Bus. Brokers, https://cabb.org/news/baby-boomers-incredible-numbers-are-buying-and-selling-businesses-part-1-2 (last visited May 17, 2024).
