Succession Planning — How to Get Started
August 22, 2020
Starting a business might be one of the proudest accomplishments of your life — growing it from the seed of an idea into a successful, flourishing company that’s making a real difference in the world and turning a tidy profit to boot. But you won’t be around forever, and when it’s time to hand off the business to someone else, you need a plan.
That doesn’t necessarily mean planning for your own death, although that’s obviously a worthwhile consideration. In many cases, you’ll surrender control well before you die so that you can retire in comfort and let someone else handle the day-to-day operations of the business. In either case, there are a lot of considerations to keep in mind.
Communication is Key
The most important thing to think about when you’re handing off your business to someone else is that you find someone who actually wants to run the business. This sounds obvious, but it can be a major problem with family businesses when the family doesn’t communicate.
If you leave your business to your children, but they’re simply not passionate about the same things you are, they’ll likely take the business in a completely different direction than the one you wanted or even liquidate it entirely. According to the Harvard Business Review, 70 percent of family businesses don’t make it to the second generation and only 10 percent make it to the third.
But this doesn’t just apply to family businesses. Whether you’re leaving your share of a business to a partner, a fellow employee, or a third party, you need to know that your business will be in the hands of someone who genuinely cares about it. Talk with them about the future of the company, how it should be run, and how involved you’ll be after you hand over the reins.
Get a Business Valuation
We’ve talked about the finances of breaking up with a business partner before, but it’s worth reiterating that a business valuation is one of the most important things you can do for the long-term success of your business.
A regular valuation — we recommend doing at least every two years — will tell you what the business and its various assets are worth, whether it’s growing or shrinking, and what a fair purchase price might be. If you’re selling your share of the business or leaving it to someone else, you’re going to know what that share is worth.
If your company is publicly traded, then the job of valuation is all but done for you. It will simply be the percentage of the company you own, multiplied by your company’s market cap. If you’re a private company, you’ll have to determine your company’s value yourself. It’s not imperative that you have your company professionally evaluated — you can pick any number you want and use that — but that value will have significant implications when it comes to taxes and other financial questions.
Create a Buy-Sell Agreement
A buy-sell agreement is exactly what it sounds like: an agreement for the terms of sale of your portion of your business. It’s a legally binding agreement that spells out exactly how a partner’s share can be divided if a partner dies or leaves the business. It’s also sometimes called a buyout agreement, a business will, or a business prenup.
Make no mistake — you need one of these agreements. No matter what your succession plan is, it won’t happen automatically. Even if you’re the sole proprietor of your business, it won’t be left to your next of kin when you die, so you need to have a plan.
Passing Your Business to Your Partners
Most succession plans fall into one of two categories:
- In a cross-purchase agreement, the remaining partners in the business purchase the shares of the business that belonged to the partner who’s leaving
- In a redemption agreement, the business itself buys back the share of the business
Sometimes the two are mixed, with the remaining partners buying some of the business and the entity buying the rest.
Where does the cash come from? One common method is called the cross-policy method, where each partner takes out an insurance policy on each of the others. If one dies, the payout is used to buy their shares.
In the case of a redemption agreement, the business itself owns an insurance policy on each of the partners and uses the payout to buy them out in the event that one partner dies. This agreement carries the added benefit of some substantial cost savings — the policies themselves are business expenses, so the costs are deductible.
Take the Time to Plan Ahead
If you’re thinking of retiring or you’re concerned about what might happen to your business after you die, you should start working on a succession plan sooner rather than later. At First Western Trust, we can help you navigate the complicated world of succession planning, examining your personal and business finances to come up with a customized plan that’s right for you, your partners, and your family. If you’re ready to start taking succession planning seriously, get in touch.
