If you run a small business, chances are you've spent so many years building the company that it can be challenging to think about what will happen when the day comes that you're no longer able to run it. Should you leave the business to a family member — or is there a long-time employee who's more capable of taking over? What about selling the company to someone else?
These questions highlight why succession planning is such an important consideration. Turning over control of your business could be one of the most challenging business decisions you may face, but several approaches could help you can plan for tomorrow.
What Is Succession Planning?
Succession planning involves creating a plan to address many scenarios, including:
- What will happen to your business if you're nearing retirement?
- What will happen to your business if you would like to move on to a new venture?
- What will happen to your business if you encounter health issues and are no longer able to oversee day-to-day operations?
- What will happen to your business if you pass away unexpectedly?
Succession planning is essential in the event of a business owner's death. It could help provide a road map for executing the business owner's wishes and may help make everything more clear to their family members and employees.
When you develop a succession plan, you would need to choose a successor, such as a relative or trusted employee. Then, you would train that person early on about various aspects of the business and your role in it. It's also helpful to create a timeline for when your successor will take over. For example, if you plan to retire in three years, your succession plan may include details on when you will begin to transition your role to the new head of the company.
Sometimes choosing a successor is difficult: A family member may not want to take over the business, or you may not have an employee in line to assume this role (or one whom you'd entrust with your life's work). In this case, you may consider selling the business.
If you choose to sell your business, your succession plan would need to clearly state your criteria for a sale. This includes making sure you receive fair market value or a certain price for your business, and determining how a final decision will be made about the sale, such as a majority vote by family members or a carefully selected board of key decisionmakers.
There are several ways to approach succession planning, most of which require specific financial protections and legal agreements.
All in the Family
As noted above, when it comes to exiting your small business, you can either sell, transfer operational control or turn the business over to a family member, as a CNBC article explains. However, all these things come with tax implications, especially for the estate tax, according to the Internal Revenue Service (IRS). So, you should talk to a lawyer and an accountant about the right approach for you.
You would also need to have either a trust or shareholders' agreement in place. A trust would be necessary if you plan to divide ownership of your company among more than one person — or if the successor you choose isn't yet of age to take over the business. In this case, another designated person would manage the business until your chosen successor can take over.
A shareholders' agreement includes details on the valuation of the company; whether your chosen successor will gradually buy into the company (and at what price and time frame); and any life insurance you've purchased that names either specific family members or the company itself as a beneficiary. This information may help the successors buy an interest in the business upon your death if you co-owned a company, or if they need to keep the business from being sold to a third party.
An insurance policy, such as whole or term life insurance, could also be used to help buy out your interest when you retire or if you become disabled and can no longer run the business. It could also provide the added benefit of giving you money to help fund your retirement or pay for your care.
The Buy-Sell Agreement
Are you concerned about the continuation of your business when you retire or if something happens to you? If so, structuring the terms of a buy-sell agreement in advance may be a good option. With these agreements, you designate a trigger event, such as your retirement, death or serious disability, in which your business interest will be sold. This agreement can be between you and a key employee — or another third party or company.
It would include details on the purchase terms of your business interest, the fair market value of your stake in the business and a valuation of the business that can be used for tax purposes. (Capital gains tax may apply if you sell the business before you die, according to the IRS.) This approach could help minimize potential conflicts and ensure the transfer process is smooth and the business continues, even if you're no longer involved.
Designate a Successor in Your Will
If you don't plan on retiring in the foreseeable future, you may just choose to pick a successor in your will. This approach often works best if you openly communicate your wishes before you put everything in writing and if there's an obvious person who will take over the business. This person may be a sibling who co-owns the business or a child who has spent his or her entire career working for the company.
These are just some of the approaches you could use for succession planning. Transferring ownership or selling a business is one the most difficult things you can do as a small business owner. This is why planning and open communication are all essential to this process. If you have a small business, it's your responsibility to protect what you've built — so don't leave succession planning to the last minute. The survival of your business could depend on it.