Experienced and effective leadership is a key component of long-term business success. However, only 35 percent of businesses have a formalized succession plan—a startling statistic considering that retiring Baby Boomers will comprise the largest exit from the workforce in US history. Whether you own your practice or advise business-owning clients, succession planning is vital to ensure a smooth transition. Keep reading to learn some top techniques and considerations to keep in mind.

Business Succession Planning: What Is It?

Before we dive into techniques and considerations, let’s quickly define what succession planning is. According to Investopedia, succession planning is “a business strategy companies use to pass leadership roles down to another employee or group of employees.” The purpose of succession planning is to “ensure that businesses continue to run smoothly and without interruption, after important people move on to new opportunities, retire, or pass away.”  

According to respondents in an Association for Talent Development report, the top reasons for creating a formal succession plan are to identify and prepare future leaders (89 percent), create opportunities for internal advancement (72 percent), and ensure business continuity (72 percent).

Business succession can happen gradually or suddenly: If it is not the result of a well-planned departure and transition, it can happen due to a triggering event such as the death, disability, bankruptcy, or termination of the owner. Events that trigger a succession can be enumerated in a buy-sell agreement. Smaller businesses may have a term sheet laying out the detailed process for the transition, while businesses large enough to offer an employee stock ownership plan (ESOP) may use a detailed offering memorandum with additional disclosures.

Goals and Techniques

Every succession plan is different, so it is important to talk to your client about their vision for the future of the company after they are gone. You can help your clients have a smooth transition by structuring a buy-sell agreement or memorializing the succession plan in a founder’s agreement. The following are some goals that your client may have for their succession plan:

• Ensuring the long-term viability of the business
• Maximizing profit for the outgoing owner
• Keeping the business in the family
• Reducing tax exposure

If dealing with a family business, the outgoing owner may want certain heirs to work in the business. You can create a revocable trust, such as a standalone trust or special purpose trust, for your client to hold the business, name trustees, define the trustees’ responsibilities, and specify how and when ownership or profits will be transferred to beneficiaries: this strategy can facilitate a smoother transition, especially if one or more of the owner’s heirs will not be involved in running the business. Annual and lifetime exclusion gifts are a way to equalize an inheritance if the business will not be divided equally among all of the heirs.

Transition of Ownership

A series of meetings with the client can provide a road map for the transition during the nine- to eighteen-month period before their planned departure. These meetings can accomplish the following goals:

• Identifying candidates to run the company
• Considering whether the firm should be merged with another company
• Determining the financial package for the outgoing owner
• Setting the timetable for the transition

If the owner does not want to quit immediately, the plan could include continuation of an office, staff support, and salary. Since the owner is often the face of the business, the owner could receive a bonus for continuing to bring in new customers.

The outgoing owner’s financial package upon departure must make sense for the continuing financial health of the business. Other financial considerations for the business transition include

• borrowing money from the bank to buy stock from the outgoing owner,
• combining a managerial buyout with an ESOP, and
• funding the owner’s pension plan with company stock.

Valuation of the Business

The valuation of business interests is a complex process, and there are a number of methods that may be used to determine value depending upon why the valuation is occurring and how it will be used. Some qualified appraisers use a formula called Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA). While small businesses may be sold for two or three times EBITDA, a company that is large enough to use an ESOP may sell for as high as five to seven times EBITDA. Valuation can be increased to maximize the profit of the outgoing owner, or it can be reduced to make the business more affordable for the new owners.

Twenty-First Century Planning Techniques

Learn more about business transition by watching the on-demand webinar “Business and Succession Planning: Twenty-First Century Transfer Techniques,” hosted by Peter S. Myers, JD, and Bill Mandel. To access the on-demand webinar, click here.