Seven Steps to a Successful Business Transition
Be sure to have systems in place before exiting your business
Spring means only one thing for most of us: baseball! Around the country, families are preparing their little league stars for game day. You probably remember giving your kids some extra batting practice after you got home from work to face that unbelievable fastball thrown by the coach’s son.
Hopefully you’ve done that for your business as well and coached your children or employees to take over the company so they are ready and able to do so. But business transitions are not easy even in the best of cases and it’s definitely not a game. You know your family, your retirement, and your employees and their families all depend on a successful transition of your business. That makes succession planning a must.
As a business owner faced with the question of succession planning, you have more than a few decisions to make, and some are not so easy. Here are seven steps to consider:
- First and foremost, you must decide who will be your successors in the business. Will it be one or more of your children? Have any of them expressed a strong interest in leading the company? Can this transition be done without causing a rift within the family? The last thing anyone wants is a long retirement full of regret and guilt. Alternatively, will it be one or more of your key employees? If they’ve been with you for a long time, they likely know the business, its history, and its potential. Again, just because they have been with you for a long time does not mean that they will make good business owners. Also, if there is more than one successor, their goals have to be aligned and they have to be able to work together. You won’t always be there to make their partnership work.
- Second, what is the business worth? What is the optimal amount your successors should pay you? You want them to succeed but you also don’t want to be underpaid unless you consider part of it to be a gift or a bonus for past services. You may choose to obtain a third-party valuation of the business. To reduce the immediate financial burden on them, you may choose to retain some ownership or sell slowly over time, with part of the sale proceeds coming from the distributions that you receive. But retaining ownership may cause your successors to be ineligible for certain loans. As for the purchase price, will it be a fixed dollar amount, or will there be some type of earn-out (a contingent purchase price)? You may want to share the benefits of business growth over the next few years. If you retain a significant ownership interest, then this is the equivalent of a contingent payout.
- You know very well that owning a business is not just about the wonderful financial rewards and the good times. We all remember the Great Recession, don’t we? The third step is to talk to your successors and determine if they are willing and able to handle the work and the risks. Do your successors have the skills necessary to successfully run the business? If the business requires borrowing, are they (and their spouses) willing to guarantee the debt? Are they mentally and financially able to handle that much risk?
- Fourth, how soon do you want to leave the business? And what does “leaving” even mean? Business transitions could take place quickly or over many years. If your successors are able to find financing (lender or investor), you could take all cash up front, if you are ready to leave and they are ready to take over. Often, departing owners want to stay involved at some level even if they are completely paid off. On the other hand, even if you desire to leave immediately, you may have no choice but to wait and get paid over time. The question then becomes: how much ongoing risk will you need or want to take? You certainly should want to stay involved and have a say in the decision-making until you are fully paid.
- Fifth, if you agree to the transition and part of the purchase price is in a promissory note, what will be the collateral for that note? Should your successors put up more than just their equity in the business? To protect against a downturn (whether due to the economy or the inability of your successors to successfully run the business), what about a mortgage on their house? You may even want to consider requiring your successors to get life insurance just in case they die.
- As you get ready to sit down and put it all on paper, you will be faced with the inevitable question of tax consequences, both for you and your successors. As a sixth step, you will need to consult with legal, tax and financial advisors to be sure that you pick the right transaction structure to minimize the tax consequences of this transition. You may want to even consider moving this to step one.
- Lastly, you may want to consider options to buy rather than actually transferring the business over to your successors. Another alternative is to simply keep the business for a longer time and, for now, find a way to fund their future.For your employees, you may want to set up a deferred compensation or bonus program. You may even want to set up a “liquidity event bonus,” giving your employees a “piece of the action” when you eventually sell.
Whatever path you decide to take for your succession planning, these seven steps will help you along the way. Take your time and do it right. As a final note, once you set a plan it almost certainly will change – perhaps just a bit or perhaps a lot. You will want to revisit these steps, because as the plan changes your feelings about these issues may change as well.
About the authors: Barb Wells is an attorney and Director at Minor & Brown P.C.
Sherap Tharchen is an associate attorney at Minor & Brown P.C.
Minor & Brown is a Colorado-based business law firm, providing practical advice, helping owners to create sustainable growth, preparing and implementing their succession plan. For more information on MB Law visit: https://www.minorbrown.com/