It’s no secret that small businesses are the backbone of the American economy, accounting for some 44% of GDP. But this also means that the future of small businesses is of central importance to both the US economy and the people (owners and employees) who make it work. And here’s another key statistic: research indicates that nearly half of small business owners in the US plan to retire in the next 10 years.
Obviously, this means that the next few years present a golden opportunity for small business owners to transition their legacies to new leadership as they prepare for a well-earned retirement. But the problem is that only 8% of those who plan to step back from the operation of their enterprises over the next decade have made full preparation to successfully transition ownership of the companies on which their employees, customers, and communities depend.
Business Succession Planning: A Tool for Growth
The fact is that for thriving, forward-thinking enterprises, a carefully designed succession plan is about much more than funding the retirement of the owner or founder; it’s a tool for helping the business continue to grow, preserving and strengthening its presence in the marketplace and cementing the legacy of those who built it. But to function that way, succession planning should start early (in most cases, more than ten years prior to the owner’s planned retirement) and, most importantly should include well-defined steps toward nurturing, compensating, and fostering the next generation of leaders, employees, and other stakeholders who will help the business legacy transition into the future.
To put it in a contrasting light, business succession plans that focus only on extracting the maximum value from the sale of the business for the benefit of the owner tend to de-incentivize or even ignore the people who will be most important for the firm’s next chapter (including its customers). Especially for family-run businesses or cases where the owner has specific intentions to promote an internal successor, this can create serious problems: not just financially, but also personally.
Steps Toward a Growth-Oriented Succession Plan
Without question, responsible business owners should certainly plan carefully for a well-funded retirement. But this can be done without disinheriting those who are best positioned to lead the company after the owner’s departure from day-to-day management.
1. Internal Succession.
Especially for privately owned family enterprises aimed at preserving multigenerational ownership, a strategy for direct transfer of ownership from the founder to a chosen successor is the usual first choice. Advantages of this model include:
- Preservation of operational and relational continuity for customers and employees;
- Opportunities for the owner to tailor mentorship and transfer values to the rising leader;
- Typically less disruptive for all concerned than an external sale.
- Of course, this process is not without its challenges, including:
- Potentially limited capital available for buyout funding by successors;
- Owners sometimes struggle to fully release responsibilities and leadership, leading to internal uncertainty or delayed transitions;
- High dependence on the readiness and leadership capability of successor candidates.
To preserve these advantages and overcome these obstacles, an internal succession plan should be implemented early: perhaps as soon as the preferred successor leader is identified. For it to work, this plan needs a longer “runway” (sometimes, more than 10 years), as the owner intentionally mentors not only the rising leader but also those key employees and stakeholders who will be essential to the new leader’s success. This planning should also include financial preparation to maximize the successor’s ability to adequately compensate the owner for the value of the business. The following steps can lead to a smoother, more satisfactory outcome for all concerned:
- Inclusive mentoring that begins early and continues for the entire term (and see above);
- Obtaining and periodically updating an accurate valuation of the business;
- Designing a graduated buyout or installment sale plan that considers the abilities of the successor and the financial needs of the selling owner. This may include a program of gifting shares of ownership over time (involving estate planning considerations);
- Preparation of the support base for acceptance of the new leader. This could involve ensuring that the rising successor is systematically included in key meetings with key customers, trading partners, lenders, and other stakeholders.
2. Selling to a Third Party.
While many sellers may think of this in terms of cashing the check, handing the keys to the buyer, and walking away, this exit strategy can actually demand a lot of the selling owner, especially if they are committed to protecting current employees, family members, and other stakeholders. Of course, there are advantages:
- Creates a liquidity event that relieves the owner of most financial responsibilities for the business;
- If an agreement is in place for preserving existing internal management, rising leaders can focus on operations, customer service, and other ongoing management concerns;
- New owners may offer leadership coaching and business strategy support for successor leadership.
But, there are some obvious challenges:
- Depending on the terms of the sale, existing management and other leadership may be financially dis-incentivized;
- Cultural mismatches between the acquirer and the business can negatively affect managers, employees, and customers;
- Career advancement for existing management and leadership may be limited within a more corporate structure.
Often, a profitable, stable business that has followed professional management and accounting standards may be particularly attractive to an outside buyer. Especially when the buyer has ample capital, the owner can generally expect to receive full or partial payment for the value of the business at closing. And if the business has growth potential, the firm may also provide funds needed for expansion. However, selling to a third party may require the seller to remain engaged in business operations after the sale for a specified time to help ensure a seamless transition to new ownership or management. The firm could also prevent the seller from withdrawing cash from the business prior to the sale.
These steps can be helpful for negotiating a growth-focused sale to a third party:
- Obtaining an up-to-date valuation for the business;
- Careful attention to designing a sales agreement that protects internal interests important to the seller, such as ongoing employment of key team members, management and advancement opportunities for family members, etc.;
- Attention to the tax implications of the sale (often dependent on the legal form of the entity being sold).
The Bottom Line for Succession Planning and Growth
Succession planning is often delayed because founders and owners either cannot imagine stepping away or do not have a clear plan for receiving adequate compensation for their equity. But a well-designed succession plan neither pushes you out nor shortchanges you. Instead, it gives you options: creating a map for you to reduce your involvement over time, purposefully prepare your successors, preserve your legacy, and provide a clear path for your firm to thrive, long after you are gone.
At GEM Asset Management, we know that there are major implications, both financial and emotional, for business owners as they consider selling their companies and transitioning to a less active role or retirement. If you are wondering how to approach this process, we can work with you to develop an individualized plan that keeps your priorities foremost.
