Succession Planning 101: Preparing Your Small Business for the Future

With all of the responsibilities a business owner has to juggle on a daily basis, it's easy to understand why planning far into the future might take a backseat. And yet, if you don't start planning for the future of your business now, you may not get the chance to take it in the direction it needs to go. That's what succession planning is all about—guiding the company forward.

With 51 percent of U.S. businesses currently owned by leaders over age 60, according to the Exit Planning Institute, the need to plan for the next phase of company ownership is approaching quickly.

Don't feel bad if you don't already have a succession plan—most small businesses don't. The reality is that only 34 percent of family businesses report having a “robust, documented, and communicated succession plan in place,” according to PwC’s U.S. Family Business Survey in 2021.

Some business owners may intend to hand the company down to family members, others plan to sell and retire, while others running a lifestyle business may arrange to simply shut it down and sell off assets.

However, if you're one of the 66 percent without a succession plan, know that unless you communicate your wishes and intentions to company leaders and formalize them through a succession plan, your business could face significant upheaval upon your departure.

To avoid chaos, decide in advance how you’d like to leave the company and with whom.

Where to start in succession planning

Many businesses lack succession plans because the owner isn’t sure what the process entails or how to begin. Fortunately, devising a plan doesn’t have to be complicated.

The first step is to identify all of your options for exiting your business. The next is to decide which path makes the most sense for you, given your financial and familial situations. The final step is to document and communicate your plan so there is no question what the future looks like for the business and its employees. A big part of succession planning involves identifying where the next generation of leaders will come from.

You have three main options for exiting a business: sell it, liquidate it, or give it away. Regardless of your approach, it's best to work with a team of trusted professionals, including an attorney, financial advisor, and tax expert.

Selling the business

Owners who are interested in selling their company frequently do so to fund their own retirement. If the majority of your wealth lies within the business, selling it makes sense.

You can sell to:

• Family members
• One or more employees, such as through an employee stock ownership program (ESOP)
• An outside buyer

Sometimes, who you can sell to depends on the investment required, so you’ll first want to have a business valuation completed to determine the current value of the business. This information will help you put an accurate price tag on it.

Then, based on what it’s worth, you can determine who your potential buyers may be.

If you’ve already decided you want to pass the business down to your heirs, you may want to start the process of selling shares to them now. If you intend to sell to a key employee or a group of employees, you’ll want to communicate the valuation with them to determine who is in a position to participate in the purchase and what the timeframe is. And if there are no current employees who want to buy it – ask first to be sure – you can opt to hire a business broker to look for outside buyers.

However, the reality is that only 20 to 30 percent of the small businesses that are put up for sale sell to a new owner, leaving up to 80 percent of owners needing a new path to getting value for the assets. In other words, have a Plan B if a sale doesn’t materialize.

The advantage of selling is that you receive the proceeds to spend as you choose. The disadvantage is that you may be asked to stay on for a transition period, so you may not be able to walk away completely just yet, and the new owners may take the company in a direction you don’t approve of or make personnel changes you couldn’t have foreseen.

Liquidating

Businesses that are dependent on the current owner for the creation of products or services (considered lifestyle businesses) are harder to sell, because once the owner steps back, the buyer may not be able to replicate their skills or process. For example, artists, hair stylists, and solo auto mechanics whose clientele buy from them because of their unique abilities typically have a harder time selling the business.

In such situations, selling off the hard assets, such as equipment, inventory, and raw materials, may be the best-case scenario.

However, even if this is the plan, make it clear who then receives the proceeds of the liquidation.

The advantage of shutting the business down and selling everything is that you’re immediately free to do something else or to retire. If there were business debts, they can sometimes be cleared through liquidation too. The disadvantage is that you are left with no assets.

Giving away

Family-owned companies, and especially those that have been around for generations, are the most likely to be handed down to the children, grandchildren, or other relatives of the owner.

However, if leaving a legacy is your intent, make it clear by spelling it out in a succession plan and in your official will. Avoid the pain and drama of employees wondering who is in charge by committing it to paper and communicating it to all interested parties, so there is no question later who is in charge.

If your business is worth less than $11.7 million, you can give it away without any gift taxes, which is a big advantage of this option, nor will you have to pay capital gains on the business’s value. As long as you’ve made arrangements for your own retirement and can afford to give it away, there are few downsides.

Starting the transition

After you’ve decided which next step for the business makes the most sense and have formalized a succession plan, begin the process of preparing the next set of leaders to take over.

Preparation is at the heart of succession planning.

Preparing might mean announcing your intention to retire in X years. It might mean promoting someone into a more senior role. It might mean creating a leadership council to begin to work together on the company’s future, or sending a key employee to a management training program.

Decide on these next steps with the involvement of those most impacted. After all, if you’re leaving the company in their hands, you want them to have a say in what happens next.

Stepping back

The good news is that you don’t have to hand over the keys and walk away if you don’t want to. In fact, many business sales involve the previous owner staying on for a number of years as a consultant to ensure a smooth transition.

Devising a succession plan is a critical first step, but don’t just file it away and cross it off your to-do list.

Revisit your plan regularly, and especially after a key employee leaves the business or if a family member decides to take a different career path. You’ll want to reassess your exit plans at that time and to take steps to hire replacements and/or reallocate ownership shares.

By reviewing your succession plan frequently, you reduce the chance of turmoil and uncertainty when you’re no longer in charge.