How to Create and Ensure a Successful Succession Plan

Running a business requires a lot of hard work. As a business owner, you may be so focused on managing day-to-day operations and pursuing growth opportunities that you put succession planning on the back burner. However, it’s important to carve out time from your busy schedule to address creating a succession plan with your family, professional advisors and perhaps others — even if you’re in good health and don’t expect to retire anytime soon.

Whereas a last will and testament ensures your wishes related to personal affairs are followed, a succession plan provides a road map for who will take over the business if you die, become disabled or simply decide to leave your current role. Your plan doesn’t need to be cast in stone; it can be modified as circumstances change. But a little forethought today can help prevent major disruptions and family disputes when you eventually leave the business. Here are some important considerations.

Defining Your Goals

A well-thought-out succession plan will:

• Allow you to shape the fate of your company,
• Preserve the value of your business during a transition,
• Reduce income and estate taxes, and
• Minimize the risk of intrafamily discord if your children play a role in the business or will eventually.

You don’t have to immediately reveal the full contents of your succession plan to all affected parties, but some general intentions should be made apparent early on. This is especially true if you decide to pass your business to heirs and need to start preparing them for that reality. Just be careful not to make promises you might not be able to keep.

Selecting Your Exit Strategy

First and foremost, your succession plan needs to address a fundamental question: How much value will you need to take out of the company to meet your retirement and estate planning goals?

The answer will influence whether you’ll be best off selling the company to an outside buyer or transitioning some or all ownership to your heirs — assuming they’re willing and able to fill ownership roles in the business. If transitioning ownership to family members is the plan, you’ll want to explore tax-efficient strategies, such as gifting, to achieve that goal.

If you lack suitable heirs and don’t wish to sell to an outside buyer, you could arrange for one or more key employees to buy the business. Just bear in mind that this typically can’t be accomplished overnight because it typically involves elements such as nonqualified executive compensation plans, loans and possibly a “key person” life insurance policy.

Suppose you decide not to pass on the business to your heirs and, instead, wish to pursue employee ownership of your company. A leveraged employee stock ownership plan (ESOP) could be a viable ownership transition mechanism.

Under this approach, an ESOP trust borrows funds to buy company stock from the business owner. Then units of that stock are periodically awarded to eligible employees and, over time, vested. When those employees retire, their vested shares are repurchased by the ESOP, allowing those employees to benefit from any increase in the company’s value. Meanwhile, the company makes tax-deductible ongoing cash contributions to the ESOP trust to cover the loan it took out to buy the owner’s shares. If this concept piques your interest, contact your CPA or attorney for further explanation.

Preparing Your Management Team

If you do decide to sell the company to an outside buyer, you may be able to preserve or enhance its value by gradually diminishing your role and transitioning ownership responsibilities to your senior executives — particularly your heir-apparent. Assuming the new team is successful, an outside buyer would be less likely to consider your departure a major risk to the company’s ongoing success or worry about the need to make immediate management changes to protect the investment.

In addition, it’s critical to think beyond how the company is currently structured. For example, suppose you’re thinking about stepping out of the picture in 10 years, and your business evolves along the lines you’re hoping it will during that time. Would your organizational chart look the same then as it does now? What new roles and areas of expertise will be required to run the business successfully a decade hence?

Don’t limit your planning to focus exclusively on your heir — though choosing and mentoring that individual is certainly important. Think about the next management tier. Who will fill those slots? Can existing employees develop the skills and experience to fill them well? Will you need to add executive talent? Such decisions will be informed by looking not only at your company’s present needs, but also at expected future challenges.

Communicating Your Plans

Once you’ve developed a preliminary plan for your company’s future direction, you’ll need to get buy-in from affected parties. This starts with open, honest discussions. Whether you expect leadership roles and ownership stakes to be assumed by your heirs or by key employees, those stakeholders need to play a role in the succession planning process. It’s particularly critical in the case of children who may not have had much involvement with the business. In that situation, you can’t make assumptions about their desires or abilities when folding them into a succession plan.

Also, in a privately held company, it’s only natural for nonfamily member employees to wonder what will happen to their jobs when the principal owner retires. Although you shouldn’t make promises that you may not be able to keep, reassure key players that you value their contributions and are working to minimize disruptions and maximize stability as you transition out of the business.

Successful Succession

Creating a succession plan isn’t something you should attempt to do on your own. Contact your professional advisors for help with the legal arrangements, as well as for assistance undertaking the necessary financial, tax and estate planning.

Once your initial plan is in place, meet with your advisory team at least annually to review and, if needed, modify it to account for any developments related to your family situation and management team, as well as to address any relevant tax law changes.

Copyright 2024

This article appeared in Walz Group’s October 21, 2024 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.