Leaving a Legacy: Effective Succession Planning
Luke Campbell – Sterling Point Advisors; Brian Autry – Kenison, Dudley & Crawford, LLC
Do you know what will happen to the business you’ve worked hard to establish when you retire, pass away, or become unable to manage the company?
According to the North American Industry Classification System, there are approximately 342,000 businesses in the United States lower middle market (generating between $5 million and $100 million annual revenue). A 2019 report by the National Association of Corporate Directors shows that fewer than 25 percent of private companies have a formal succession plan that identifies directions for transitioning from a current CEO or managing partner to a successive owner. Without a proactive plan, business owners are often unprepared when they are ready to retire or exit their businesses, leading to suboptimal results for themselves, their company, and their employees.
For business owners, a formal succession plan satisfies a number of goals:
- Secure a financial future for themselves and their families
- Identify the right leaders and partners to carry their company forward
- Provide continued security and growth opportunities for employees
- Prepare for effective financial and tax planning for significant change in asset composition
Therefore, the most important and valuable thing you can do as a business owner to ensure a successful transition is to plan ahead. Don’t wait until you are ready to retire to start this conversation. Identifying a clear plan while you are still actively involved in the company will prevent confusion and family disputes when the time to transition comes around. In addition, it makes your business more marketable and attractive to potential investor groups. Too often, business owners spend a lifetime building their businesses but settle for liquidating their assets, handing the keys to an unprepared employee or family member, or accepting an unsolicited offer due to improper planning. In fact, according to the International Business Brokers Association, 20 percent of lower middle market business transactions occur because the owner received an unsolicited offer.
Methods of ownership transition can vary. One common method is a buy-sell agreement. For example, when a certain event occurs (such as when a current owner passes away or retires), the business is sold to employees of the company, family members, or the owner of another business. A buy-sell agreement establishes an estate tax value for the business and is also useful in allowing shareholders in a family business to purchase the previous business owner’s interest at a predetermined price. Please note, however, that this option is most useful when only a small number of shareholders are involved. Otherwise, it can be costly.
You may also choose to “gift” your business to keep it—and its assets—in-house. It seems simple enough just to leave your business to your children, but that has serious tax implications. Those running the company you leave behind often struggle with paying estate taxes after your death. Also, any bank loans or lines of credit may be called by the bank, requiring any outstanding loan amounts be paid immediately. It can put any business in a financial pinch and often leads to the new owners having to sell the business. A tax professional can guide you through certain IRS tax code provisions (Section 6166 and Section 303 of the tax code) available to help qualifying businesses avoid that.
Another option is to market your business to potential investors. There are thousands of investor groups and strategic buyers in the United States who are interested in businesses of all types. M&A advisors are often used to help business owners identify potential investors, cultivate interest, and assist with negotiations. One advantage of this route is that a formal marketing process often leads to multiple competing offers. Unsolicited, direct offers are often not the most competitive, and multiple offers can lead to higher value for your business as well as allow you to select the best partner to carry your company forward.
As you can see, there are a lot of things to consider when determining how your company will continue on when you are no longer at the helm. A succession plan helps you ensure a smooth transition of leadership over multiple years and prepare your business for a successful sale to a new ownership group.
The sale or succession of your business is much more than a transaction. It is the culmination of your life’s work. As you consider your eventual transition, ensure the best possible outcome for your family, your company, and your employees: plan ahead and get advice. A team of trusted financial and legal advisors can ensure your succession plan is thoughtfully created and thoroughly executed.
About Sterling Point Advisors: Sterling Point Advisors is itself a family-owned business providing M&A advisory services to family-owned and privately held businesses. We help business owners navigate the strategic challenges of growing or exiting their businesses.