Structuring a proper succession plan effectively can take some fine tuning.
Have you ever wondered what’s going to happen to your small business when you retire? If you are an owner who’s been stressed deciding who should take over your small business when you retire, pass away, or become incapacitated, you are not alone.
According to the Small Business Administration (SBA), there are approximately 33.2 million small businesses across the United States.1 However, a recent survey shows that only 1 in 3 family businesses seem to have a detailed document outlining a succession plan should something happen to the owner.2
As a business owner, you put a lot of time and energy into cultivating your commercial enterprise. You want to make sure all your hard work lives on in a manner that best aligns with your vision.
Whether you plan on liquidating your business or wish to let a successor take over, having a proper succession plan in place can help to preserve your business legacy. But structuring a proper succession plan effectively can take some fine tuning.
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Establish a Timeline
One of the first steps when establishing a proper succession plan is to create a timeline for when succession should start. In most cases, you will have a lot of flexibility to determine when and how succession will occur.
Many business owners choose a predetermined future date, often one that aligns with the date they want to retire. Another option is to set your plan in motion only if certain triggering events occur, such as if you become disabled or pass away. These events are a little less predictable but are an important consideration in the planning process.
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Identifying Your Successor
It may seem simple, but naming your successor is a big decision that can have serious consequences for your business. For example, naming one working family member over another could create tension in your personal life. In other cases, naming someone other than a family member could also spark discord amongst children or loved ones.
Regardless, whomever you choose as your successor, whether it be a family member, key employee, or group of trustees, your choice should be clear and should put you and your business’s best interest first.
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Standardize Your Operating Procedures
Your business may run like a well-oiled machine, but once you leave you want to ensure those succeeding you have a proper plan to keep your business operating at peak efficiency. Its essential you establish set protocols and standard operating procedures to help guide your business into the future when you are no longer around. Things you should nail down include an organization chart, employee handbook, job descriptions, training materials, and key workflows.
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Obtain a Formalized Valuation
If your succession plan involves liquidating your business or allowing other owners to liquidate their business shares, its important to establish a formal valuation for what your business is worth. There are a variety of ways you can determine the value of your business and the valuation methodology is often included in a Buy-Sell Agreement if there are multiple owners.
Many owners utilize a seller’s discretionary earnings (SDE) calculation, which involves an adjusted cash flow method, leveraging multiples based on current industry standards. However, you can also utilize other methods including the capitalization of earnings or an asset-driven approach.
Whichever valuation method you choose, be sure to document your choice and have your calculation updated periodically to align with your overarching succession goals.
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Figure Out the Funding
Business owners often overlook the fact that selling or transferring ownership of a business comes with a cost. One of the most important features of a successful succession plan is to create an outline for how to properly fund the process.
There are several ways to fund your succession. In the unfortunate event of your passing, you may want to have a life insurance policy in place that can kick in and get your business through that hurdle. Its also important to consider any tax consequences that your estate might have to handle.
In the event of a sale, the buyer will need to obtain a loan to pay you for the business. If you are gifting the business to a successor, you may need to secure a business loan to help smooth out your cash flow and keep your business running strong until the new owners get their feet wet.
If you have questions on which funding option is best, consider speaking with a financial advisor who can navigate you through different options and help minimize any undesired tax consequences.
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Baltimore-Washington Financial Advisors is a nationally recognized Fee-Only and Fiduciary wealth management firm, providing comprehensive wealth management since 1986. We integrate investment management, succession planning, retirement and estate planning, and tax services so you can relax knowing your money is safe. Don’t forget to book an appointment with us to ensure personalized attention and expert guidance every step of the way! We serve clients throughout the Mid-Atlantic, nationally, and specifically in Annapolis, Baltimore, Ellicott City, Hunt Valley, Catonsville, Pikesville, Bethesda, Columbia, Rockville, Gaithersburg, and more! We’re here to provide you with the best services and advice when you need it. For more information on how we can help, visit our website, or give us a call at 410-461-3900!
Sources
1 https://advocacy.sba.gov/category/research/facts-about-small-businesses/