When it comes to starting and running a business, there are so many factors and eventualities that you have to plan and prepare for. It’s not enough to just run your business, you need to be prepared to handle almost every situation that the world will throw at you to be able to succeed.
Businesses that don’t plan, fail. It’s a big reason why 1 in 5 businesses fail in their first year. But your business isn’t going to end up as a statistic as long as you avoid common mistakes and plan like there’s no tomorrow.
Now, succession planning for business owners seems like something small businesses and startups shouldn’t care about. Succession planning is for those near retirement, or looking to sell and get out, right?
Succession planning is an important tool for all businesses, of all sizes. In this guide, we’ll show you why succession planning is so important, the different types of succession plans that you can use and finally give you the ins and outs of how to create your own succession plan.
Let’s get started.
What is a succession plan?
A succession plan is a plan for what happens if you, or a partner, leaves the business. It helps translate ownership (or leadership positions for larger businesses) positions, giving both employees and clients a clear path of what’s going to happen next.
A succession plan involved the following elements:
A succession timeline
This gives details on when a planned succession might take place (i.e. for a planned retirement).
This is a list of people who would replace you, or your partner, in the event of your succession. You may only have one potential successor in mind, or you could have a list of possible suggestions. If a list is provided, the list of successors is written in priority order with each person’s strengths included.
Formalized standard operating procedures (SOPS)
This is a collection of documents designed to educate employees and your successor on the normal operation and running of your company. It can include items like company procedures, employee handbooks and training material.
A business valuation
This is an external assessment of how much your business is worth, and needs to include the method by which it’s valued. It’s important to keep this one updated, so you’re not providing an out of date assessment of your business.
Your succession funding
Everything needs money, including your succession. This part will detail how you plan to fund your succession, which could include life insurance, a seller’s note or more. All financing options can be discussed with your accountant.
Fundamentally, succession planning for business owners will give step-by-step instructions of what happens if step down, sell the business, or if anything happens to them. It not only helps plan for the future but makes sure the business can carry on ruining without stress on your family if something unexpected happens to you.
What businesses need a succession plan?
Every business should have a succession plan in place.
Think of succession planning as less like a retirement plan, and more of a fail-safe set of instructions. It’s like a last will and testament for your business, but for hopefully less morbid circumstances.
Despite their importance, one study revealed that 58 per cent of the small business owners had no business succession plan in place. If you don’t have one yet, take this as your wake up call to get started.
When is the best time to create a business succession plan?
We’ve outlined that succession planning for business owners is essential – no matter what type of business you’re in.
But like everything, there are right times to plan and wrong times. If you’re just starting up, it may be too early to think about passing your business along when it’s not even running yet. It’s like planning for your child’s education plan when they haven’t even been born yet.
However, that doesn’t mean you should put off your succession plan until it’s nearly time to retire. To help you understand if now is the right time to plan, we’ve put together this quick succession planning checklist.
- Do you operate a complex business that only you understand? If you were to leave right now, would anyone be able to take over in your place or duplicate your success?.
- Do you have employees? If your business employs someone, a succession plan is needed to ensure that your employees are looked after and can continue their employment after you leave.
- Do you have repeat clients or ongoing contracts? If you were to leave the business mid-way through the contract, would someone else be able to fulfil the work? Where would your clients go to?
- Do you already have a successor in mind? If you’re running a family business, you might already be thinking of leaving your business to your child, or if you work closely with someone, you might want them to run things in your place. But without a successor plan, they wouldn’t be able to take over.
If you said yes to one or more of these points, it’s time to plan.
What type of succession plans are there?
Now it’s time to get into the nitty-gritty details of succession planning for business owners. Succession planning can come in different types of forms but generally will follow one of these five types of plan.
1. A co-owner succession plan
This type of succession plan is where you sell your shares or transfer your half of ownership to a co-owner. It can only be used if you have a business that’s set up to share ownership, such as a Partnership, Limited Liability Partnership (LLC) or Public Limited Company (PLC). You can find out more about these company structures here.
When setting up these types of businesses, you can draft a mutual buy-sell agreement that, in the event of death or other incidents that prevent someone from working at the company, the other owners will buy up the shares and take full ownership of the company.
This type of agreement works as a temporary succession plan but can miss some essential details and requirements. So even if you have one of these deals in place, you may want to create a succession plan to clearly state what will happen to your shared ownership if you left the company.
A buy-sell agreement is also dependant on your co-owner having the cash to buy-out your shares, which they might not have at the right moment. So to ensure that your co-owner can take your share of the business, a succession plan can write to include life-insurance policies to cover the cost.
2. An heir succession plan
This type of succession plan is where you pass over your ownership of the company to a family member. It’s used most commonly in family businesses, who want to keep the business in the family and often groom the next of kin into taking over from a very early age.
It’s also seen as an attractive option for those that want to make sure their family are provided for if the worst should happen, therefore handing over the keys of the kingdom.
Even if you’ve planned, or verbally stated to pass on your business, a succession plan is still needed to make the change official and clear up any confusion or inner-family fighting over the ownership, particularly if you have more than one child. You don’t want to leave behind a family of children fighting for the throne.
An heir succession plan will:
- Clearly outline who takes over the business and provides instructions for the takeover. If you have more than one family member, it could also include how other heirs will be compensated.
- Define any structural changes to the business in the event of your heir taking over.
- Outline day-to-day responsibilities and processes, making sure the business runs smoothly and all areas are covered.
Some heir succession plans also induce buy-sell agreements, which allow other heirs to sell their shares in the business to the active one.
3. A key employee succession plan
This succession plan is where you sell your business to a key employee inside of it. This is perfect for those that don’t have a co-owner or family business but want to keep the business running with those that are actively involved in it.
For example, you could leave your business with your second in command, or a hardworking employee that’s been there to build your company with you from the ground up.
A key employee succession plan requires:
- Clear instructions to leave your company to the key employee, as well as any changes to your organisation chart, day-to-day roles and responsibilities.
- A buy-sell agreement that allows your successor to buy out your shares of the business and take ownership.
Generally, most employees don’t have the spare cash to just buy out ownership of the company they are working for. So when it comes to this type of succession plan, a lot of businesses opt for seller financing to help transition ownership of the company. This type of financing allows your successor to pay you, or your family, back over time with a 10% down payment.
4. An outside party succession plan
This succession plan is where you plan to sell your business to someone outside your organisation. It’s a great option for those without co-ownership or a clear line of succession, helping to clear up any financial worries from selling the business.
In order to use this succession plan, you’ll need to keep an up to date business valuation to prove that your business is a good investment to potential investors or entrepreneurs that want to take over.
Although you have more potential for income by using an outside party succession plan, there’s also more room for roadblocks. It might take a longer time than you expect to find a seller or a recent valuation might make your business worth less than your originally thought.
And, in the event of your death or unexpected leaving, it could leave your family with a lot of stress trying to find a buyer in a short space of time.
If you want to have an outside party succession plan, we’d recommend using business brokers to help facilitate the sale while you focus on the day-to-day running of your company.
5. A company succession plan
This business plan is where you sell your ownership and shares back to the company itself, which is then distributed among the remaining owners. This means you’re not allowing one person to take over, but instead have the remaining owners have a larger share of the business in your absence.
This type of succession plan is good if you have a company with a lot of co-owners, but if you work with just one partner then it’s not the right type of plan for you.
To create this type of succession plan, you will need to agree on a cross-purchase agreement with each owner, or create an entity purchase agreement that can be funded with a single life insurance policy for each owner. Like any of the other succession plans, your accountant and legal representation will be able to help you iron out the small details here.
Succession planning for business owners
Succession planning for business owners can seem like a stressful or complex experience. but there are just a few key steps that you need to follow to create peace of mind that your business and family will be protected if anything unexpected causes you to leave the business early.
First, choose who you want to be your successor and what type of succession plan that you want to create. If you’ve already got someone in mind, this process should be an easy one.
If you have co-owners or partners, you may want to consider a co-owner or company succession plan. If you have no one in mind to take over, you might find that selling your business to a third party is your best option.
Once that’s decided, it’s time to go visit your accountant and legal team. They’ll help you decide the best way to fund your succession and get any legal paperwork arranged and completed on your behalf. That way you can concentrate on running your business, knowing that it’s in great hands after you leave. They’ll also be able to help you get your business valued.
When creating your succession plan, you may also want to think about what your successor needs to know about your business to succeed, drawing together any documents about your processes or work that will help in the day to day running. If you employ people, you’ll also want to include organisation charts to detail everyone’s roles and responsibilities.
And that’s the fundamentals of succession planning for business owners. Need more business advice?
Business4Beginners has you covered.