What will happen to your small business if you die? If your answer is, “I don’t know,” then consider yourself in the majority. According to a survey conducted in 2015 by CNBC and the Financial Planning Association, less than 30 percent of small businesses have a written succession plan.
This figure is staggering, especially in the context of today’s aging population. Consider this: over one-half of the nation’s 28 million small business owners are older than 50. Not that succession plans are just for the aged. Young, budding entrepreneurs also need to consider the possibility of their death or their disablement affecting their business. Young or old, if you do not have a succession plan, now is the time to decide who is going to run the company in your absence and how they are going to assume ownership.
Keeping it in the family
Many small businesses are started with the idea of creating a family legacy. That’s probably why we see so many companies carrying on a family name (Ford, Wal-Mart, S. C. Johnson & Son). Many of these companies still have significant family ownership, with S. C. Johnson & Son in its fifth generation of family ownership.
Keeping the business in the family makes sense in many circumstances. With a long-running company, there may be many family members who are quite knowledgeable of the business and its products and services. Many family members may be long-term employees, officers, or advisers of the company. Often, even the simplest form of small business, the sole proprietorship, is jointly run by married founders.
In these circumstances, it may make perfect sense to you to name a family successor. But to have a successful transition, it is vitally important to ensure that this decision makes sense to your family members, especially those whom you are considering to assume ownership. That perfect candidate may not want to be a business owner. They may not even want to work in the company at all. Candid conversations need to begin with family members to identify those willing and able to assume ownership as well as those who are not.
Despite your desires as the company founder, family ownership may not be a viable option, especially in the beginning. After all, you may not even have a family member to pass ownership to. In this instance, the lack of a succession plan is going to create havoc to the lucky ones left to manage your affairs. Don’t assume that you will live forever. Think long and hard about your key employees or even your key competitors to identify a successor. You can always change your mind later.
Communication is the key
Once the successors have been named, the entire management team and all key employees need to be notified of the decision. Open communication is the key to executing your succession plan. Your openness will let everyone know exactly where they stand with you and your business. This may cause some tension and may even cause some key employees to eventually leave the company. But it is much better to address these issues now when you are able to explain your business decision. You do not want your personal representatives to have to defend your business decision that they may not be able to explain.
Family members who are not involved in the business but who will be affected by your decision also need to be notified. Again, this may cause some tension at home. Just remember that treating everyone fairly does not necessarily mean treating everyone equally. A child actively involved in a family business may inherit 100% of a business, when his or her siblings are not involved.
Spouses and other heirs along with your executors and personal representatives need to understand how your business will execute the succession plan and how the heirs will be compensated for the sale of your business.
Remember, open communication is the key to your succession plan.
What is your business worth?
Of course, any succession plan must recognize the value of the business that you own. Even if your plan is to leave the entire business to your heirs, the value of your business will need to be determined for estate tax considerations. There are many different ways to calculate your company value – multiples of earnings, multiples of sales, discounted cash flow, and liquidation value are just a few. I recommend working closely with your accountant to determine the best way to measure the true economic value of the business.
Once the value is determined, you will need to decide how the succession plan will be funded. Will your successor need to find outside third-party financing? Or will you provide a means of purchasing your interest from your estate through life insurance? What if you suffer a permanent disability? How will that affect the funding of your succession plan?
Keep your succession plan updated
Now that you have a detailed, written succession plan, remember that the plan is a living document. It will need to be changed and updated as life goes on. You may survive your successor, or your successor may move on to another company. Your children may grow and mature into viable successors. Make a commitment to read your succession plan annually and update as needed. Your family will not regret your attention to detail.