Succession planning is one of those things that all small businesses should do well in advance of when the plan is actually needed. Unfortunately, most businesses don’t do this. According to an October 2023 survey, roughly 80% of small business owners didn’t have an exit plan a year before they put their business up for sale. This suggests that most owners started thinking about succession at approximately the time of sale, instead of years ahead of time (which is the path suggested by experts).
Why is this the case? Simply put, small business owners are busy people. When it comes down to prioritization, it makes sense that owners focus on today’s problems instead of tomorrow’s. But deferring succession planning can leave you in a frantic, precarious state years down the road. And in a worst case scenario, failing to plan for your company’s future can lead to a failed exit from your business. Luckily, preparing for tomorrow doesn’t have to be overwhelming or terribly time consuming, especially if you start early.
What exactly is succession planning?
Succession planning can be evaluated from several angles, but primarily the idea is to come up with a strategy that lets your business operate smoothly, regardless of movement within the company. That movement can look like someone in a leadership role retiring, or can take the form of a liquidity event like a sale of the business to a new owner. A good succession strategy should revolve around employees at all levels in order to retain knowledge and promote a strong and stable workforce that can move up the ladder and fill open roles.
Strong business owners understand that succession planning isn’t a one-and-done process. It’s something that should be thought about carefully and frequently (perhaps annually) as staff, business, and general circumstances change.
What are the benefits of succession planning?
The benefits of succession planning can be broken out into short-term and long-term benefits. In the short term, setting up a succession plan and actively including a broad swath of employees in the process creates a skin-in-the-game culture. Knowing that they are an important part of the company’s present and future fosters a sense of ownership, which in turn leads to higher retention and company growth. Making career development and advancement a large part of your strategy also leads to more knowledge being shared, which creates a stronger business.
Longer term benefits include setting yourself up successfully for a liquidity event, which is the focus of the rest of this blog post. Done right, a good succession plan will help you transfer ownership, gain liquidity, maintain or better your financial standing in retirement, and leave your business in stable hands.
What options exist for succession plans?
There are a variety of exit plans that are available to small business owners, some of which are listed below. Some may be more viable than others, depending on your particular circumstances.
Selling your business on the open market
Selling to an outside buyer is often the first option that comes to mind when thinking about retirement. This plan involves a reliance on the current market and number of qualified buyers who are interested in purchasing your business at a reasonable price. Steps to take when considering selling your business in this manner include:
- Getting a company valuation – hire a third party to value your company based on a multitude of factors, including debts, assets, current and future profits, etc.
- Organizing your business records – especially the financial ones. Any buyer is going to want full transparency into what they are buying.
- Listing your business for sale – this piece is often done with a business broker or an online platform that essentially acts as or works with a broker.
- Engaging with buyers – you’ll want to screen buyers before sharing information to make sure they are financially capable of buying your business. Serious buyers will then complete due diligence and expect to negotiate.
As you might imagine, all of the above takes time, which reinforces the fact that you need to start planning early. Keep in mind that selling to a third party, whether it’s to a competitor who knows your industry well or to someone who’s brand new to the space, often means that you’ll need to stay onboard for several months or even years to keep things running smoothly post-sale.
Keeping your business in the family
Perhaps you’ve been part of a family business for generations. Or maybe you’re hoping that your children, grandchildren, nieces or nephews will be interested in being the starting point of a new family business. In either case you’re in good company; over 60% of the US workforce is employed by a family-owned business, which is defined as a business where the majority of ownership lies within a family.
While passing business ownership onto a family member can sound more straightforward than selling to a third party, that’s not always the case; when making succession decisions, it’s not uncommon to face the kind of conflict that only happens within a family. Additionally, it’s critical to assess whether there’s genuine interest – not to mention suitable leadership skills – in the family member who will take over.
While most employees understand the realities of keeping a business within a family, you may risk serious morale or retention issues if you discount rewarding and promoting non-familial employees. An easy solution for this is implementing a phantom stock plan for your key employees who will not be inheriting an ownership role, but are an integral part of the company and should reap a financial reward upon a change in ownership.
Selling your business to key employees
Employee ownership can be a thoughtful, lucrative exit for small business owners who plan ahead. Who better to run your business than the employees that know it best? Loyal employees at the helm all but guarantee continuity of your business practices. This succession model is a great way to keep a stable company running long after you’ve liquidated your shares, as well as a way to cement your legacy for years to come.
One of the most common ways to exit to your employees is via an employee stock ownership plan, also known as an ESOP. In a survey of small business owners, nearly half of respondents thought that ESOPs were a good vehicle for a company’s succession or transition of ownership. Other vehicles used include worker cooperatives and management buyouts.
The best way to start planning for an employee-owner succession plan is by communicating with your employees and gauging interest. Educating everyone on the complexities and benefits of owning a stake in the business is critical. Finally, it’s important to note that a phased transition over the course of several years is often the best way to enable an exit to employees. This is yet another reason to begin succession planning soon rather than later.
