What to Know Before You Start Succession Planning
August 25, 2020 - What do you want for your business when you leave it? While there are many factors to consider in succession planning, your choice will ultimately come down to answering that question. When you sit down with your team of advisors to discuss how you'll exit your business, you have several options. Finding the right one for your business depends on your goals.
Optimally, you've begun planning for the sale or transfer of your business as soon as you become its leader. Regardless of the type of business or where you're at in the process, here's what you should keep in mind for your succession planning.
Review Your Succession Planning Options
When you begin succession planning, you'll be presented with three major options for handing off your business:
- Third party sale to a strategic buyer or private equity.
- Internal sale to family, a key employee, or an employee stock ownership plan (ESOP).
- Liquidation to formally close the business, distribute assets, and repay creditors and shareholders.
Each of these paths contains its own nuances and procedures that you should account for when planning your exit strategy. For example, the structure of the sale or transfer will change depending on which option you choose.
When selling to a third party or private equity, the buyer traditionally dictates many of the terms of the deal (though you may have some room to negotiate certain terms that are most important to you); when exiting with an internal sale or transfer plan in place, the onus is primarily on you, the current owner, to create and dictate the financial structure of that transfer.
"Family and internal buyers often don't have the resources to finance the deal up-front," says Paul Longsdorf, CPA, Tax Partner, Client Manager, and member of the construction industry team at Redpath. He mentions a few of the questions that could come up: "Will you transfer to family with gifts? A tax-efficient trust? If you're interested in a payout, will you achieve it through long-term compensation, share transfer over time, limited partnership, ESOP? The selling owner doesn't want to transfer control and then hope to get paid."
For some businesses and industries, the succession plan options are more limited. "Sometimes, private equity isn't all that interested in acquiring a construction business, or the strategic buyer could be a competitor that the seller has been bidding against for years," Paul says. In cases like that, private equity can still be a viable strategy (depending on company value and market position), but it could also be a signal that you should explore other succession planning tactics with your advisor.
What Are the Keys to Your Business?
Sorting through the options available to you, and what each option means for your business, is part of the succession planning process. Because no single option is right for every company, you should look at what makes your business unique to narrow the field.
"What makes your business valuable?" Paul asks. "What is it that gives your company value – and how will that value continue proving itself after you've left the business?"
These value factors can be key employees, the structure of your business, operational systems or a series of valuable customers and relationships – whatever helps your business maintain value over time. "If it's just you," Paul says – if your day-to-day involvement is a key driver of your company's success – "you're going to need to make some changes before you have what could be considered a saleable business." Identifying those value indicators will be essential to choosing and pursuing a succession plan and exit strategy.
Let Your Goals Be Your Guide
With your options on the table and focused on the factors that make your company most valuable, your succession planning decision returns to the original question: What do you want for your business? What are the criteria that you, as a business owner, expect of your exit plan?
"Is it legacy?" Paul asks. "Money? Do you want to ensure your employees are taken care of?" Along with the value of your company, your goals will help you find which succession planning tactic is right for your business. Here are a few common goals key stakeholders often have in mind when weighing their succession planning options:
- Highest sale price: Third party sale can help maximize the sale price of your business at the expense of some control of the business after your departure.
- Control: Internal buyers often don't result in the highest sale price, but they often allow you to maintain a greater level of involvement than third party sale.
- Maximizing tax benefits for the company: If income tax benefits for your company is a goal for stakeholders, ESOP can give you an edge, providing significant advantages. A management buyout is generally tax inefficient, and selling to an outside buyer is usually a taxable transaction, yielding no tax benefits.
- Quick exit: Paul calls liquidation "the hammer" of succession planning options – a tool to enact a quick and final exit that ties off loose ends and effectively divorces the owner from the business entirely. It is also, sometimes, the unintended consequence of failing to plan.
With a basic understanding of your succession plan options and the questions that each raises, you can begin to prioritize your goals and expectations post-exit. Every internal transaction is different – whether selling to family, employees, ESOP, or some combination of tactics, be sure to discuss the details with your lawyer, financial advisor, CPA, and buyer.