Succession Planning: A Blueprint for Long-Term Success
No one understands the importance of planning better than business owners. Delivering projects on-time and on-budget for clients requires a tremendous amount of planning and communication.
Unfortunately, too often business owners don’t apply the same rigor to planning for the future of their own businesses as they do when planning for clients’ projects. Failing to plan for life after the founder or current owner(s) can have serious financial and emotional consequences for the business owner, the owner’s family and the business.
Succession planning is the process of creating a plan for how the business will transition to the next generation of leaders. Regardless of whether the transition is triggered by the owner’s retirement or by some involuntary event such as death or disability, succession is inevitable.
If done properly, succession planning can provide powerful benefits for business owners, their families, their business partners and the company’s employees. It can help ensure that the business continues thriving after the founder or current owner is no longer involved in the business and facilitate a smooth transition to the next generation of leaders.
From a financial perspective, succession planning is essential for maximizing the value of the company and the amount of wealth that owners can pass on to their heirs. It also gives the owner a thoughtful and organized way to cash out of the business when the time is right. This last point is especially important for capital-intensive businesses.
Don’t Let Succession Planning Happen by Default
Anyone who has ever run a business knows how easy it is to let the day-to-day operations distract you from thinking about long-term goals. Many business owners have good intentions about succession planning, but it often gets put on the back burner when the demands of winning new clients and delivering for existing ones swallow up all of the owner’s time and energy.
As a result, succession “planning” often doesn’t occur until it is too late to do it effectively. One of the most important elements of a succession plan is establishing a value for what the business is worth. With many small businesses, the vast majority of the business’s value is represented by the owner’s expertise, relationships and reputation. If a business waits to establish the value of the business until a few years before the owner wants to retire—or worse, after the owner has died or become disabled—the value of the business will be significantly discounted because of the owner’s pending (or recent) departure.
Succession planning doesn’t just protect the owner’s financial interests; it can also provide valuable peace of mind. In the case of a company that does not have a succession plan in place and experiences the death or disability of the owner, the owner’s family members and business partners are forced to deal with some very difficult decisions at the worst possible time. Succession planning helps to alleviate this burden.
Let Time Be On Your Side
When it comes to succession planning, the earlier a company does it, the better. The best time to plan for the transition of the business is when all of the important players are still involved in the business and the business is growing. The earlier an owner starts thinking about succession planning, the more options the owner and his or her advisors have to tailor the plan around the owner’s goals for retirement, wealth transfer and the company’s sustained success.
Going through the valuation process helps the owner understand, not only what the business is worth now, but also the factors driving the growth of the business (value drivers). In some industries, valuations are based primarily on operating profits; in other industries, year-over-year revenue growth or percent of revenue that comes from recurring clients are more important. Understanding what these value drivers are early in the business’s life gives the owner more time to build a business that will be valued highly by future owners.
Knowing how much the business is worth—and what it might be worth 10, 20 or 30 years down the road—also allows the owner to plan for retirement and transfer wealth to family members in a tax-efficient way. In most cases, the business accounts for the vast majority of the owner’s net worth and cash flow. It is impossible to properly plan for retirement and wealth transfer if the owner doesn’t know what the business is worth.
Constructing a Succession Plan
Like any major project, creating a strong succession plan is the result of several well-coordinated steps:
- Articulate the owner’s goals: The owner should identify his or her goals for the business, retirement and wealth transfer.
- Identify and train the next generation of leaders: Preparing the next leaders should begin well before the current owner is ready to retire.
- Build a team of trusted advisors: This should include accountants, lawyers, insurance consultants and other professional advisors.
- Establish a buy-sell agreement: This contract lays out how the owner’s shares will be purchased by the company or other partners and establishes a value for those shares.
- Fund the buy-sell agreement: Identify where the money to buy the owner’s shares will come from; options include life insurance, disability insurance, sinking funds, the business’s current cash flows and partners’ private wealth.
- Review the plan every 2-3 years: As business conditions and personal circumstances change, revisit the plan regularly to make sure it still achieves the owner’s goals.
Building a Legacy
Most business owners want to see their company prosper long after they are gone and provide a source of income for heirs—as well as steady employment for current employees. This doesn’t happen by accident, however; the owner must be willing to invest time and energy into grooming the next generation of business leaders.
The Green Bay Packers are a good example of an organization that understands the importance of succession planning. In 2005 the Packers used their first-round draft pick to select Aaron Rodgers, even though the team already had future Hall-of-Famer Brett Favre as their quarterback. The ultra-talented Rodgers had to play the role of understudy for three seasons, but he eventually replaced Favre in 2008 and has led the Packers to the playoffs in six of the last seven seasons.
Preparing the next generation of leaders takes more than just time, energy and good intentions. Identifying the right people to take over the business and training them may require skills the owner doesn’t have. That is why many successful businesses work with outside advisors who specialize in guiding companies through these transitions.
Having a formal succession plan in place can be very helpful in attracting highly driven and talented people who can one day succeed the current owner. The opportunity to purchase equity in the business—and a structured plan for buying into the business—are great ways to give younger executives a vested interest in the company’s long-term growth.
Special Considerations for Family Business
While the issues described above apply to all small and mid-sized businesses, family businesses face a unique set of challenges related to succession planning. This is especially true when there are multiple children and not all of the siblings will be equally involved in running the business.
Andrew Keyt, the executive director of the Family Business Center of Loyola University Chicago, said that two-thirds of family businesses do not survive past the current generation and that 60% of family business failures are the result of poor communication, rather than business or financial problems.
“When it comes to succession planning for family businesses, communication is the name of the game,” Keyt said.
He said it is extremely important for family businesses to not only have a plan for passing the business to the next generation, but also to make sure the plan is well communicated across the family and the company. Family businesses should have regular family meetings and a strong board of directors that includes trusted advisors from outside the family.
“It is important to remember that succession planning isn’t an event, it’s a process,” Keyt said.
Planning for Success
Business owners pour an amazing amount of blood, sweat and tears into building their companies. Too often, however, planning for the company’s future doesn’t occur until it’s too late to do it effectively.
Creating a succession plan is certainly an investment of time, energy and resources. But it is an investment that pays tremendous dividends for the owner, the owner’s family and the company’s employees. By creating a blueprint for the transition to the next generation of leaders, business owners can create something that is built to last.