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8 Steps for Successful Succession Planning

August 22, 2013

It is improbable that a business will last forever.  It‘s impossible for its owners.  Unless the owner wants their business to die with them, arrangements have to be made for a transition or sale.  Doing nothing is a choice and carries with it the natural consequences of that path.  Succession planning should be done, even if there are no immediate plans to retire, as a precaution against unforeseen, unintended future events.

Succession planning is not an event.  It is a process that establishes new ownership and management and provides the ways and means to put them in place with a reasonable likelihood of success.  The transition could be to a successor already working in the business, a knowledgeable family member not in the business or a new hire that will eventually run the business.

  1. Preparing for succession planning: Preparing for transfer to a successor is not much different than preparing for a sale.  Critical information needs to be assembled and organized so that the successor and their advisors can do their due diligence.  This includes financial statements, an examination of profit centers, cash flow analysis, a review of the top customers and vendors and the susceptibility to loss if relationships are terminated, geographic coverage, evolving ways business is conducted and an examination of the company’s business model, organization chart and suitable backup.
  2. Not an arm length transaction: Most sales to successors are not necessarily at arms-length.  One of the parties is usually not in an equal position to negotiate price and terms.  Further, terms play a strong role since many times payments are made from the business’ cash flow and not independent investment sources.
  3. Valuing the business: Before any plan can be presented, a sense has to be obtained of the business’ value. Entrepreneurs who want to pass the baton need to come up with a price that would be suitable to them, their family and the people paying it.  In many instances, the value of the business is based upon what the buyer can pay, either to the seller or to the lenders who provide buyout financing because, in a transition to current management, it will most likely be from someone who hasn’t the money to pay for it.  The allocation of the purchase price also needs to be considered taking into account the tax treatment to the seller and buyer.  This, too, would have an effect on the price.
  4. IRS’ valuation concern: Valuations for transactions between related parties may attract the interest of the Internal Revenue Service.  To the extent the transaction is not arms-length, the IRS might deem the difference between the transaction price and an arms-length price as a taxable gift, inclusive of prohibitive penalties and interest.  The IRS recognizes fair market value as the appropriate standard for determining the sale price between related parties.  It is advisable to engage the services of a credentialed valuation expert to assist in determining the sale price.
  5. Timing: Time is an important element in structuring the transaction.  A lot more can be done if five to ten years were available than if done in one or two years, or less, if a death or disability is causing the transfer.  An orderly transfer can accomplish much more for everyone involved.  The longer the time, the easier it will be to train and ease the successor into a leadership role.  The sooner you start… the better.
  6. Structuring the transfer: A succession plan involves the sale or transfer of the business to the next generation of owners, be it relatives or long term employees.  The needs of the seller have to be balanced against the ability of the business to make the payments. The payments are not just the direct payments to the owner.  They could be to a bank, other lender or to a venture capital group that is a co-owner with the designated successors who provided the funding so the retiring owner could get an upfront payment.
  7. Leadership and management skills: The successor needs to have the essential skills to carry on.  The current owner has to decide if the chosen person or people will be able to maintain and grow the business.  If the qualities are there, then there should be grooming, training, team building and the passing on of knowledge and insights over a period of time.  This is another reason for advance planning.
  8. Assemble a team: A team of advisors should be assembled including a CPA, attorney, financial planner, business appraiser and possibly a business broker or investment banker, business coach or psychologist.

There are many ways a business can be transferred in connection with a succession plan.  Each carries a cost, tax and/or risk consequences and practical considerations.  The bottom line is to develop the plan early and work out all the numbers to determine its viability.

One Comment leave one →
  1. Robert Nagler permalink
    August 22, 2013 10:46 am

    Hi ED You give good sound advice in your comments

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