One of the most difficult yet important decisions that an owner or owners in a business are faced with is how the business will survive or be transferred when they are no longer serving in the same capacity or roles within the business. Many, if not most owners pour their time, energy and resources into growing a successful business and want to ensure that it continues on whether due to retirement, disability, or even death. It is imperative to put together a logistical plan, considering all of the financial and non-financial factors that will need to be addressed to ensure a successful transition of ownership. There are a number of different ways to plan for business succession that if implemented may help your business or organization to thrive long after you depart as owner.
According to Fit Small Business, there are 5 different ways to transfer ownership in a small business. Selling to a co-owner, leaving it to an heir, selling to a key employee, selling to an outside party and selling back to the company. Each one of these has pros and cons to them and it is wise to consider which ones are best suited for your company. In some cases, such as with a sole-proprietorship, the options may be more limited and can cause the succession planning process to be difficult in ensuring a seamless transition. Where there are co-owners or partners involved, the options are greater but the other considerations such as timeline, valuation and the method of funding can create some complications. In this blog post we are going to share with you some of the strategies that can be implemented into your business succession plan.
Selling to a co-owner: Business partnerships are often formed at the beginning or in the early stages of growth for small companies. Generally you see two (or more) owners who execute a partnership agreement that lays out the amount of equity each partner is entitled to as well as what their responsibilities are to the partnership. Over the lifetime of the partnership the company grows and develops with their customers or clients which often can lead to the value of the company to increase as a whole, which each equity holder will realize individually. But what if one of the owners wishes to no longer be involved in the business? What if they suffer an injury that impares them from being able to fulfill their responsibilities? What if something tragic happened like a sudden death for one of them? Any of these situations can be dealt with through setting up a small business succession plan and the best time to implement one is at the outset of the partnership or creation of the company. It is a best practice to periodically review the plan as time goes by and the business evolves.
So what is the best strategy to wind down a partnership like this? The answer is “it depends.” If you are looking to sell to a co-owner or partner you can choose to self-fund the transaction, take out a loan from a financial institution, or negotiate a long-term payout of the equity. In the case of an unexpected situation such as death or disability, oftentimes a business will use a buy/sell agreement that is funded by life insurance. You can use either term life insurance or a permanent policy (universal life/whole life) for this and the proceeds are used for the remaining partner or partners to buy out the interests of the deceased or disabled pattern. Term insurance tends to be more cost effective but does not pay out if the departing owner retires or is disabled. There are permanent policies that can be utilized for those instances. Buy/Sell agreements are taken out between all of the owners involved and have to be continuously funded and updated as the business equity valuation grows.
Outside Purchase: Sometimes there is nobody to sell to within your organization, which can cause an owner(s) to look outside for interest in buying the business and its assets. There are competitors that may want to acquire for strategic business purposes, entrepreneurs and even private equity firms that may want to purchase to strategically grow and spin off the business. The type of business that you own will make a big difference in the valuation of your company for this type of transaction. If your business is in your name as well as heavily reliant on you as the owner of the relationships, it could lead to a lower valuation than if your company was ready to be transitioned in a more turnkey manner. Some business owners may strategically decide to brand their business outside of their own name so that it can help down the road for this type of a business succession. One of the drawbacks to this type of a transition is that the owner or owners are usually giving up the culture and in some cases the future direction of the business to the new owners that probably do not have the same emotional or financial ties to the business as it has existed pre-sale. Selling to an outside buyer generally happens in a cash transaction or procurement from the buyer of a business loan.
Heir: If the goal of the owner or owners is to keep the business in the family and you have identified one or more members of the family that could “take the reigns” and run the organization, then this is a good way to handle a business succession. It can deepen the client relationships that have been fostered over the years and also decrease the amount of change and frustration that can arise when a company comes under new ownership. It also allows for the owner or owners to still have some involvement in business as they are often consulted or kept around to keep the status quo while the heirs (as owners now) make important decisions on the growth and direction of the organization. In most cases (over 70%) this is not a successful transition due to the fact that most inherited businesses within a family are changed or renamed by the successor and in many cases the family member lacks the skills or drive necessary to keep the business moving forward and growing. While many business owners wish to have the business stay in the family for years to come, it is one of the most likely options to have it be messy and cause disruption to the business. Especially if you have qualified and talented people working for the business that feel minimized or marginalized in the new organization.
Key Employee(s): If there is someone or a group of people that are integral parts of the company and wish to continue working for and owning either all or a part of the business then selling to a key employee is the way to go. This type of business succession plan is generally the most efficient and positive way to execute due to the strong business relationships with the clients as well as the culture of the firm itself. Generally the key employee or employees are capable and willing to assume the responsibilities of running the organization and have been around for a long enough period of time to have already made an impact in the culture and success of the organization. Many times as the company grows through the years and the owner or owners get older, they will try to cultivate, educate and develop the key employees or employees that they would like to transition the business to. It can have positive long-term financial implications to the owner and also the employees that will take over in the future.
If you have a business that has equity to it, business succession planning is one of the most important steps that you can take to ensure that the hard work and efforts that have been put in through the years can provide you with the greatest value when you sell or something unexpected happens to one or more of your owners. If you have a business currently but do not have a solid business succession plan in place, reach out to any of the financial advisors at Walkner Condon Financial Advisors for a no obligation meeting and we are happy to help get you started with this important step. There is a lot that goes into the planning involving business retirement plans, structuring the payment or payments to best align with your personal goals and needs, as well as finding the right resources to make the plan come together. We are happy to help!