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Preparing to Pass Your Business to the Next Generation

Posted by Gregory Robinson | May 28, 2024 | 0 Comments

Running a company involves daily demands that often leave little time for contemplating the future. While strategic agility allows for quick responses to external changes, it's crucial to set baseline goals and establish a roadmap for the next quarter, year, and beyond.

Small business owners understand the power of planning, yet many lack a succession plan for the inevitable day they step away from their business. Inadequate attention to talent pipelines and succession processes poses significant organizational risks that could ultimately destroy the company.

Importance of Succession Planning

Succession planning should ideally start five to seven years before the expected transition. However, to best prepare for the unexpected, it's wise to build a succession plan from the company's inception.

Failure to Plan: Planning to Fail?

According to the 2023 North America Family Business Report from Brightstar Capital Partners, 9 out of 10 family businesses have no plans to reduce the family's stake in the business. Harvard Business Review notes that family businesses tend to outlast typical companies because they prioritize leaving a legacy over short-term profits. However, failing to plan for leadership succession can derail any company, whether it's a family business or a Fortune 500 firm.

The direct costs of insufficient succession planning include increased spending on recruitment, training, and overtime; loss of business continuity and revenue; excessive leadership turnover; and harm to customer relationships. Indirect costs can impact company culture and result in the loss of institutional knowledge.

How to Make a Smooth Ownership Transition

America is on the cusp of "The Greatest Wealth Transfer in History," as baby boomers begin passing on $30 trillion to younger generations. Some of this wealth transfer involves family business ownership interests, with millions of boomer-owned businesses expected to change hands over the next 10-15 years.

Having the right people in place to take over at the right time increases the odds that the company will thrive. An effective succession plan should incorporate the following steps:

  1. Identify Positions in Need of a Successor: This includes owners, founders, and mission-critical positions such as executives, managers, and key employees.
  2. Set Eligibility Requirements and Performance Expectations: Develop criteria for filling important positions when they become vacant.
  3. Build a Talent Pipeline: Identify internal candidates who meet succession requirements. If none exist, consider outside hires to strengthen the talent pipeline.
  4. Prepare Successors to Take Over: Successor candidates need teaching, mentoring, and compensation incentives to succeed.
  5. Document and Regularly Evaluate the Succession Plan: Have policies, procedures, and governance documents that support succession planning, and revisit them annually to refine and improve the plan.
  6. Determine the Business's Worth: Establish the fair market value of the business before transferring interests. A professional appraiser or certified accountant can assist with this process.

Succession Planning Legal Considerations

Common choices for a successor business owner include a co-owner, family member, or key employee. Regardless of the choice, thorough legal preparation is essential for a smooth transition.

Legal Considerations for a Smooth Transition

  1. How Will the Business Be Transferred? There are several options for transferring a business to new owners. Family businesses might gift the company to successor heirs for tax and estate planning benefits, implement a partial or complete sale, or place business assets in a family limited partnership or family limited liability company. A sale to business partners typically involves a buy-sell agreement, a cross-purchase agreement, or an entity purchase agreement. Essential documents for selling to an outside party include a purchase agreement, financial documents, and nondisclosure agreements.
  2. Does the Plan Cover the Unexpected? A succession plan should incorporate contractual arrangements addressing events such as death, disability, divorce, and bankruptcy that might require successors to step in sooner than expected.
  3. Is Everything in Writing? To reduce the likelihood of disputes or litigation, every step in the business succession process should be put in writing, reviewed by an attorney, and signed by all parties.

Legal Help for Successful Succession Planning

Starting and running a business is driven by the hope that it will endure. Building a valuable business that lasts requires more than hard work; it also means having a concrete plan for the owner's exit that doesn't disrupt business operations.

Relinquishing control of your business can be difficult, but having a succession plan makes it easier, smoother, and more successful for everyone involved. Succession planning should start early and be revisited often with the assistance of a business attorney. To start planning your exit, please contact our office to schedule a meeting.

About the Author

Gregory Robinson

Attorney Gregory Robinson is a native of Alabama. He earned his Juris Doctor (J.D.) degree from Mitchell Hamline School of Law and holds a Master of Business Administration (MBA) degree from Rice University. Prior to practicing law, he worked as a strategy consultant in the financial industry...

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