Choosing the right successor can make or break the future of your business. The next-in-line should have long-lasting passion for the work, the company’s respect and the expertise needed to maximize profits and promote business longevity.
Can your successor make the tough decisions you may have struggled with in the past?
It's a question worth pondering, especially considering only 30% of family-owned businesses survive the second generation. Many of these failures result from a lack of succession planning. According to the Exit Planning Institute, 78% of businesses have no transition team, and 83% have no written transition plan.
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An effective succession plan ensures the company remains a thriving enterprise. It simultaneously covers the owner's retirement while transferring control to a successor with the resources and knowledge to lead the business to the next level.
Finding the Right Successor
When evaluating potential successors, you should first analyze your own role by assessing the crucial aspects of running your business and what specific skills and qualities are needed for success.
When it comes to a family business, often an adult child or other family member is the common choice to lead. A strong succession plan clarifies this person's responsibilities as well as the roles of other family members. It's important for everyone to understand their value.
If it is clear a family member may not be the one to take over, you will then need to weigh other options, such as team members and external candidates.
When considering internal and external candidates, you should examine both the skills they possess and the ones they must develop. Once you understand what may be missing in each candidate, you can consider the growth process needed to prepare them.
Grooming the new leader several years in advance ensures the transition will be successful. You will need to develop them and confirm your business has everything it needs for daily, monthly and yearly operation. Often, this includes formal management training, incremental increasing responsibilities and face-to-face introductions with clients.
If your family member, internal or external candidates aren’t the best options, you may want to plan far in advance for a potential sale. Even if you don't plan to retire soon, a succession plan must account for the unexpected.
Children and Family Dynamics
A 2019 Family Business Survey conducted by the National Bureau of Economic Research Family Business found that 58% of family-owned businesses adopted a succession plan. Having an effective succession plan with distinct guidelines can prevent conflicts between family members.
For example, a succession agreement that clearly defines the rights and responsibilities of each family member can head off disagreements between adult children and second spouses. In addition, it can establish what the retiring owner will receive in income and what the successor can expect in terms of business liquidity. Although disagreements are common, having a clear framework for working through them will make it a smoother process for all parties involved.
A Smooth Transition
A successful succession plan creates a structure the business can follow through the transition. A mission statement creates a starting point that commits all stakeholders to staying on the same page. It should include company core values, goals for the transition and established responsibilities. Ensuring a succession plan is rooted in the company’s values is essential to a meaningful exit.
Transitions require a team of experts, such as an attorney, CPA, financial adviser and insurance expert. When family is involved, a family dynamics expert may be a particularly worthwhile decision. The team should know the concrete steps required to complete the transition.
Retention of key employees is one of those steps. Consider employment agreements, stock options plans and any other inducements you wish to provide as part of your exit.
A succession plan should also account for tax implications and savings. Owners who are concerned about estate taxes can consider gifting the business prior to retirement to lower the size of their taxable estate. When estate taxes are not a concern, transferring ownership after death allows heirs to receive a step up in basis and pay fewer capital gains down the line, versus receiving the business during the original owner's lifetime.
Structures and Tools to Minimize Transfer and Estate Taxes
When leaving your company to heirs, there are many methods to minimize taxation. One of the most effective is a family limited partnership.
A Family Limited Partnership (FLP) can help facilitate the business succession and possibly save money on taxes. Each family member owns shares and has voting rights in proportion to their holdings. General partners are managers of the firm and are entitled to receive a management fee. Limited partners have no management responsibility and receive dividends.
Owners can transfer shares to the next generation at discounted values while also maintaining control of the business. This makes the FLP a viable method when business ownership will be transferred over several years.
As a result, the new owner(s) can see reduced estate taxes up to 20% to 50% under its pre-FLP value. Also, income shifts to lower brackets, creating a tax-efficient transfer.
Building a Better Tomorrow for Your Business
Succession planning outlines responsibilities and manages expectations for all parties involved so that a business is set up for continued success. Don’t wait to consider succession planning until there is a talent crisis. A strong transition will take years of preparation to implement.
Further, you’ll need to prepare for life after you transition your business. Having a comprehensive retirement plan in place and knowing how you will spend your money in retirement is just as important as having a succession plan in place.
Organizing a strategy for the future of your business will help avoid any major disruptions that can create problems on revenue streams or other internal conflicts. In particular, family succession plans provide a template for transferring the business to the next generation. A business’ key differentiator will always be talent, so it will only prove beneficial to invest time and resources to build your business a better tomorrow.
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