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Published on September 16, 2020 | Webster Bank
Although many business owners wish to pass their businesses on to future generations of family members, less than 30 percent ever do.
Why? More often than not, it’s due to a lack of succession planning.
Developing an effective plan to transfer the ownership of the company you’ve worked so hard to build isn’t easy. It involves the complex and time-consuming processes of business valuation, negotiation, funding arrangements and finding and designating successors or future owners to run the business once you retire, leave the company, get divorced or pass away.
But if you want to ensure that your business lives on long after you’re gone, here are a few tips you can use to build a strong succession plan.
While some business owners start to plan about five years before retirement, unexpected life events are a key reason that business owners should start planning early and review the plan periodically.
Indeed, there are signs that can indicate when that right time may be, including:
Equity can be a powerful retention and hiring tool for key employees. The need to develop management succession can, in part, be solved by creating liquidity in company stock, which can be achieved through an employee stock ownership plan (ESOP) transaction.
ESOPs help owners retain operating control no matter how large a share is ESOP-owned. They allow owners to repay debt with tax-deductible or tax-free dollars, enabling the seller to maximize a cash-out through higher leverage. ESOPs also enable the seller to sell shares to a ready buyer in stages over time. They can also serve as an employee-retention/hiring tool in the form of nonpublic stock.
However, transaction costs can be a burden. You should anticipate the fees associated with advisers needed to lead negotiations, and manage the process in a timely manner. Living up to the fiduciary responsibilities of being a trustee can be costly, and requires diligence, prudence and skill. Successors must be willing to protect the assets of the trust for beneficiaries, such as the stock representing a retirement benefit for employees.
Succession planning is different for every business. However, an effective plan includes:
Estate planning, for example, is increasingly popular, with the inclusion of gifting ownership of the business from one generation to the next. This type of transition protects the value of the business by lowering your cost basis. Your trusted legal and financial advisers can offer guidance in this area.
Excellent technical and leadership skills may be obvious qualities to look for in a successor, but a candidate who is a good cultural fit for your operation is equally important. Business owners should also look for someone who is aligned with them strategically, as well as on track for assuming a greater role and able to fulfill expectations within the same timeframe as part of your succession plan. Business owners should look for someone who will serve as a steward of the family’s assets moving forward, which is particularly important if a sale is not involved.
They can serve as a sounding board for strategic decisions. During succession planning, the board should be active participants throughout the process and be involved in assessing ownership options, analyzing risks and holding current owners accountable for both managing the process and ensuring successors are positioned for success. Another important role for the board is to provide oversight to safeguard the best interests of the owners, whether those owners are part of an ESOP or not actively involved in the business. The board should also ensure that the equity value of the business is maximized during the sale.
Succession planning requires the involvement of many team members across the business to design and implement a plan, including finance, legal, tax and human resources. You may even consider bringing your trusted team of advisers into the discussion before a decision is made to transition the company. Their early guidance can help make each step of the process smoother.
Having industry expertise, an investment banker can value a business using various methodologies, including: market comparables and discounted cash flow, which is based on the projection of the business’s future revenue streams. In particular, investment banks can identify unique attributes of your business as well as patents and trademarks, brands and licenses, competitive advantages, tax considerations and barriers to entry, all of which can factor into the valuation.
The key to long-term success depends on effective planning. Incorporating these tips into your plan can be a good start for a smooth transition of ownership to the next generation.
The opinions and views in this blog post are those of the author, and are not intended to provide specific advice or recommendations for any individual. Please consult your tax advisor regarding your individual situation.