The Importance of Small Business Succession Planning
written by: William Busse•edited by: Ronda Bowen•updated: 8/14/2010
Small business succession planning ensures that a company will continue to operate after the retirement or unexpected death of the owner. With advanced planning, the transition can be seamless while providing continuity and security for the owner, employees and customers.
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The Business Succession Plan
The development of a small business succession plan can often prove to be a challenging and emotionally difficult process for the owner. Envisioning a future without the founder of the business serves as a reminder that time continues to pass and that nothing remains the same forever. Even with these unpleasant realities, most entrepreneurs recognize the importance of protecting their family and partners by crafting a plan that will provide a seamless succession when the appropriate time comes.
When sufficiently addressed in the years prior to the actual retirement of the owner, the transition can unfold smoothly while eliminating uncertainty for both employees and customers. Unfortunately, many entrepreneurs that planned meticulously in the development of their business neglect to prepare for their own succession. This often leads to a leadership vacuum that can ultimately cripple the business.
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The Proper Time to Plan
Family owned companies remain the backbone of the economy, comprising 95% of all American businesses. Yet only 30 % of these small companies survive into the second generation and only 10% continue into the third. This sobering reality makes careful succession planning extremely important for the entrepreneur who hopes to see their business continue beyond their own tenure.
The appropriate time for small business succession planning is at least five years prior to a planned retirement and preferably before the age of 60. Allowing for sufficient time creates a stress free environment where the various aspects of the plan unfold in coordinated steps. This ensures the least amount of disruption to those who depend on the uninterrupted continuity of business operations.
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Components of a Successful Plan
Small business succession planing differs in complexity and specificity, but every arrangement should include the following elements:
* Selecting Key Personnel: This is the most important and difficult issue to resolve. Many owners automatically choose a family member to serve as their successor or simply ignore making the decision to avoid family conflict. Basing the choice on criteria other than business knowledge and competence is the primary reason second generation businesses often fail. It is important to recognize the skills and abilities of each person that will participate in the business, and divvy up responsibilities and ownership accordingly.
* Create a Timetable: From the moment a successor has been selected, a time frame for the process should be established. This includes a gradual shifting of responsibilities from the current owner to the future management team. A timetable helps promote the creation of a training program and provides specific markers to track the progress of the transition.
* Prepare for Retirement: The emotional impact of an entrepreneur leaving a business can not be underestimated. A lifetime of work that resulted in a successful company is difficult to walk away from. It is important for the owner to carefully plan for life after the business and pursue these opportunities with the same passion and commitment that was shown during their business career.
* Establish the Company’s Value: Whether the business will be sold or inherited, it is important to establish a reasonable value as a basis for the transaction. This is usually arrived at through an independent analysis of company’s fair market value. The resulting assessment can be incorporated into the succession plan along with the development of a funding source.
* Understanding Tax Implications: Business sale and inheritance tax laws are complex and frequently change. Current law provides a one million dollar exemption for passing assets at death through the gift tax exemption. The legal status of the business and the ownership arrangement will usually dictate the structure of the acquisition based on the most favorable tax consequences for the parties involved.
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Due to the complexity of tax laws and estate planning, it is essential to secure the services of a qualified attorney and CPA to help explain the various options and assist in developing and implementing the succession plan. This can include structuring the transfer through a cross purchase or entity purchase agreement and establishing a funding mechanism such as life insurance.