What Is Business Succession Planning?

In short, business succession planning is figuring out how to transition a business interest to someone else. That’s an oversimplification, but that simple statement is the seed from which the giant tree of business succession planning has grown. The more detailed definition for this series is as follows:

The process of determining the method (how) to transfer ownership and management control of a business interest to the next generation, key employee(s), or third-parties. Business succession planning is a multidisciplinary process that requires collaboration among the full team of advisors including the CPA, Attorney, investment advisor, banker, insurance agent, valuation expert, etc. Do not forget about the business owner(s), the company’s CEO/CFO and other key executives/managers/employees, as they collectively provide the bridge between the analytics of the team of advisors and the application to this specific company situation.

The team of advisors and the business owners/executives/ employees cannot/should not independently navigate the planning process. Winston Churchill once said “He who fails to plan is planning to fail.” However, we must plan appropriately as Abraham Maslow once said “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.” The point in juxtaposing those quotes is to show that business succession planning does, in fact, require a plan and that plan must be tailored to the specific needs of each, unique business. Without collaboration, the business owner/executive/employee group tends to default to the “failure to plan” camp, while the team of advisors tend to default to the hammer/nail scenario. The results are either no plan or a plan that doesn’t work (possibly worse than no plan).

Ultimately, the objective for any business succession plan is to address the business owner’s unique goals. The majority of business succession plans will have the following characteristics:

  • It will provide a roadmap;
  • It is a living breathing document/plan;
  • It allows the business owner to manage change;
  • It is the result of a coordinated effort between the team of trusted advisors and the owners/business; and
  • It is coordinated with the owner’s estate and financial plan.

While there are 2 certainties in life (death and taxes) to plan for, there are also a number of events that a comprehensive business succession plan should address including retirement, illness/disability, or other foreseeable events. There is no “off the shelf” or cookie cutter solution as each plan will be unique to the business, the owners and the situation. However, many succession plans will address some or all of the following questions/issues:

  • Can ownership/management be passed on to the next generation, employees or a third-party?
  • Is the next generation/family member ready, able, and willing to operate the business?
  • Will the retiring owner have sufficient assets to comfortably retire and will he or she be willing to “retire”?
  • How will the business transition successfully upon the owner’s death?
  • Who will make decisions in the event the owner is disabled or incapacitated?
  • How will the owner minimize income, capital gains and estate/gift taxes without jeopardizing the non-tax elements of the plan?
  • Are there marital property, divorce, or other family law related issues that might affect the plan?
  • If a family member is not ready or able, then who will take over ownership and/or management?
  • Will the transition of ownership be accomplished via gift, sale or a combination thereof?
  • If the business interests will be sold, how will the sale be financed?
  • What is the value of the business?
  • What will the plan look like from a structural and timing perspective?
  • What legal documents are required and who must be a party to them?

Why is Business Succession Planning Important?

As mentioned above, there are many questions/issues to address in the business succession planning context. If the issues are not discussed or the questions are not answered and a plan is not put into place, circumstances could devolve after the death, incapacity/disability of the business owner or other unforeseen event involving the business owner. Those circumstances could spell disaster for the business and the family with the most glaring negative results being a forced sale of the business for less than the optimum price, a larger than necessary tax bill or, possibly worse, a breakdown in family relations.

According to recent reports, the generation currently holding majority of wealth will transfer over $16 trillion to younger generations over the next three decades. A good number of those transferring wealth will be business owners as 9 million of 15 million business owners in the U.S. were born in or before 1964. Unfortunately, most business owners wait until the 11th hour if they plan at all. Statistics show that 3 out 4 (75%) of business owners do not have a succession plan. That is a frightening revelation considering that the business likely represents the majority of the owner's net worth/wealth and it is the owner’s primary source of income. In many cases it is the primary income generator for the entire family. In addition, the owners are also the central/key persons in regards to the day-to-day operations, systems, vision and management.

Given the owner's unparalleled importance to the business and the inevitability of death (at some point), why is it so common for business owners to kick the succession planning can down the street? The numbers again provide insight into this phenomenon in the family business context where we see about 90% of business owners harboring the belief that their business will remain in the family in 5 years. The statistical reality is that only about 30% of family businesses survive into the 2nd generation. Only about 12% of family businesses survive into the 3rd generation and only about 3% survive into the 4th generation.

There are certainly always exceptions and business owners would not have built a successful business without overcoming challenges along the way. However, the statistics clearly show that it is not easy to transition a business from generation to generation or from person to person. It is also not easy or comfortable for many individuals to accept, discuss and plan for their mortality. Beyond that, the day-to-day operations always take priority (“too busy”) and mom/dad are not ready or willing to include the next generation in the planning process. As a result statistics show that 70% of family business transfer fail due to:

  1. Lack of trust and communication
  2. Lack of development within the business of the next generation

The likelihood of a successful business transition can be substantially improved through proactive and comprehensive planning that involves, not only, the team of trusted advisors, but the key employees and family members in the process. In the coming section, this series will address how to start the planning process and how to develop, implement, and revise/refocus the business succession plan.