Succession Planning – Complete Guide

If you have spent many years developing and growing your business, selling it on the open market may not appeal to you as much as passing it on to someone you know and trust. This process is called succession, and a succession plan is the strategy you use to make it happen.

Planning succession well in advance helps you to prepare and train potential successors for an important role within your business. This makes it easier for you to attend training or have a holiday, as you will know your business is in good hands. Succession planning is particularly beneficial if the business owner dies suddenly or becomes ill, as the business can continue.

Whether you want to pass your business on to someone in your family, or sell to a partner or trusted employee, having a formal succession plan will:

  • help maximise the return on your investment
  • ensure a smooth transfer of ownership and control
  • minimise disruption to business operations.

This guide explains the different types of succession, and how to develop a plan to make succession as simple and efficient as possible.

Family succession

If you plan to transfer your business to a family member – either as a gift or through sale – you need to consider how this will affect both your business and your family.

Choosing a family successor

When choosing a successor from your family, always think about what’s best for the future of the business. While you may want to set up your children financially by giving them the business, this could cause problems in the long run if they don’t actually want to take it over. You need to make sure your successor(s) has both the necessary skills and commitment to take the business forward. Avoid making a decision based on emotion. It can be a good idea to establish a board of non-family members to get an objective opinion.

Be aware of potential problems when choosing a family successor. Choosing just one successor may cause conflict if others are equally interested in taking over. Or, if you appoint more than one successor, this may lead to arguments as there is no clear leader. If the successor(s) don’t agree on how the business should be run, this can cause significant problems.

Ideally, your successor should have to ‘earn’ their role, not just be given it because they are family – this can upset other employees who are qualified to take over. To get some idea of a potential successor’s suitability and interest, you could organise a trial period during which they work in all departments of the business. If you have more than one successor, it might be a good idea to delegate areas of responsibility based on each person’s particular skills and goals.

Ownership and management

An important consideration in family succession planning is how you will transfer both ownership and management. Ask yourself the following questions:

  • Will you transfer both ownership and management to family members?
  • Will ownership be equal among family members?
  • Will the management team include non-family members?
  • Do you need to change the business’s goals and long-term objectives?
  • How do you measure the success or performance of the succession?
  • Which family members will be actively involved in the business? What are their roles and responsibilities?
  • Will any family members have non-active ownership?
  • Does your successor need training or mentoring to overcome any lack of skills?
  • Do you want to act as an adviser once you have transferred ownership?

Financial and legal issues

You will need to think about the legal and financial implications of family succession and include these in your succession plan:

  • Are you gifting or selling the business to your family?
  • Do you need to set up a trust as part of the succession? Forming a family trust to own and operate the business on behalf of your children will have tax implications.
  • If you are selling your business to a family member, will you get its market value? Getting a professional valuation will ensure you are rewarded fairly for all the work you have invested and will help avoid financial disputes.
  • Would you prefer to receive a regular dividend from the business rather than a lump sum?

Be sure to get professional legal and financial advice before selling part or all of your business.

Communication and dispute resolution

Open communication is a key part of family succession planning. You need to include both family and key staff in any decision-making related to future management and ownership. Their feedback is vital. Regularly review your plans with family to make sure they are aware of, and happy, with progress.

You also need to make sure you have a process for resolving disputes. Family businesses can be emotional environments. A trusted outsider such as a lawyer, accountant, or family business adviser, can help provide an objective opinion.

Non-family succession

If you don’t have any likely successors in your family, or your family is not interested in taking over your business, you have 2 options for non-family succession:

  • sell your business to employees ­through a management buyout
  • sell your share of the business to other owners through a buy-sell agreement.

Management buyout

A common succession strategy for small and medium business owners is a management buyout – selling your business to managers or loyal employees. Management buyouts have both advantages and disadvantages:

Advantages

  • Both you and the new owners will have some certainty about the future of the business.
  • People already involved in the business are in the best position to understand its strengths, weaknesses and culture.
  • Relationships with suppliers and customers are already established.
  • Employees may feel more secure in their jobs. In open market sales, external buyers may be tempted to replace staff with their own.
  • Having a stake in the business can improve productivity, innovation and morale. This stems from a change in mindset from employee to owner.
  • New owners will be motivated to make the business successful as they will receive the profits.
  • You do not need to sell or disclose confidential information to a competitor.

Disadvantages

  • Management team may need training or coaching.
  • There may be disagreements over the purchase price.
  • The financing must meet the seller’s needs and also leave enough working capital in the business. A buyout that leaves no cash after the sale can create major problems.
  • Managers may be keen to buyout a business to save their jobs. Do they have the funds or experience to run the business in the future?
  • If the buyout doesn’t proceed, you must carefully manage relationships between yourself and managers or staff.

This process needs to be managed over time and openly communicated. Always work with professional advisers to help management through each stage of the transaction.

Buy-sell agreement

If your business is a partnership, you may have a buy-sell agreement in place. Buy-sell agreements determine how the remaining partner(s) will buyout your share of the business in the event of your death, long-term disability or retirement.

Buy-sell agreements are legally binding contracts that explain:

  • when owners can sell their interest
  • who can buy an owner’s interest
  • how much an owner’s interest is worth
  • where funding will come from to pay for an owner’s interest.

Because your partners may not have enough funds to buy out your share of the business, and any liquidity in the business will be required to keep it operating after you leave, insurance will be a key part of any buy-sell agreement.

How to develop a succession plan

Succession is about ensuring the ongoing success of your business through a timed transfer of ownership and control. A succession plan should define exactly who will take over the business, when they will take over the business and how they will take over the business.

For many owners, the idea of handing over control of their business can be confronting. A professional business mentor can help you deal with the emotional impact of succession as well as the practical details of your succession plan.

Planning your succession

You should create your succession plan well in advance of actually leaving your business. Research shows that succession can take more than 2 years to plan. Ideally, your succession plan should be part of your overall business plan and reviewed regularly. It should be flexible enough to change according to your circumstances.

Choosing a successor

Your first priority is to identify a likely successor. Generally, your succession plan will be either:

  • a family succession plan, which involves setting up a trust, gifting or selling the business to family members.
  • a non-family succession plan, which involves selling your business to an employee(s) or other owner(s) – often called a management buyout.

What to include in your succession plan

In general, your succession plan should address financial, legal and operational strategies for your exit from the business. While the details will be different for every business, it may help to answer the following questions as you develop your succession plan:

Operational issues

  • When do you plan to leave the business?
  • Will you be completely removed from the business or do you want to stay involved in some aspects?
  • What are your successor’s responsibilities?
  • What training or development will you organise for your successor(s)?
  • What are the risks involved in succession?
  • What will the business look like once you leave? Who will step into key roles?
  • Are all your employee contracts, work agreements etc. up to date?
  • Are your plant and equipment in good order?
  • Have you talked to key suppliers and customers about the succession?
  • Have you considered intellectual property and privacy policies?

Financial issues

  • Are you selling the business to your successor(s) or gifting it?
  • What is the market value of your business or your share of the business?
  • What are the financial and tax implications of succession?
  • What insurance policies do you currently hold in the event of a disability, death or injury?
  • How much income do you need to retire/leave the business?

Legal issues

  • Will there be a change in legal structure when you leave?
  • Do you need a legal document that dictates the terms of the succession?
  • Do you need to change/transfer any registrations, licences or permits?

It is important to consult a professional business adviser when developing your succession plan. You should also get input from your family and key people in the business, especially your likely successor(s).

Implementing your succession plan

Implementing your succession plans means setting a realistic timetable to meet key milestones. Milestones in the succession plan should include:

  • identifying a successor
  • business housekeeping (e.g. key dates for financial and legal requirements)
  • successor training
  • staged transfer of responsibilities
  • final handover.

Make sure to communicate this timeline to everyone involved in your business so they understand what is happening and when. Stepping back from your business can be an emotional and difficult experience, so having clear goals and time frames can help you to let go.

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