Small businesses with 20 or fewer employees make up approximately 90% of all businesses in the United States. Unfortunately, most of these businesses will never survive the next generation due to a lack of business succession planning on the part of existing ownership. As a financial planner, and one that meets with business owners on a regular basis, I am truly concerned about this disturbing trend and what it means, not only for owners and employees, but for our economy at large. I have asked Marshall Clay, JD, CFP®, a partner at The Welch Group, to make sense of the challenges facing small business owners particularly as it pertains to business succession planning.
Stewart: Marshall, what is the biggest mistake you see small business owners making in terms of planning to transfer their business to the next generation?
Marshall: The biggest mistake is waiting too long to develop their succession plan. When a small business is getting started, owners rightfully make day-to-day operations their top priority. Once a business becomes a viable entity, owners owe it to themselves and to their employees to develop comprehensive succession plans that outline a vision for the future.
Stewart: Why is it so important, from a personal standpoint, for business owners to think about business succession planning sooner rather than later?
Marshall: For most small business owners, their largest financial asset is their business. To put themselves in the best position for retirement (either by choice or due to adverse circumstances), they must devise a plan to sell their business. In our experience, it can take years to develop an effective succession plan. There can be many reasons for this, but one big reason is that often you must develop the talent to take over running the business. Business owners too often underestimate the depth of their own relationship, management and operation skills and assume someone else can easily step into their shoes when the time comes. More often than not, that’s a big mistake.
Stewart: How should small business owners begin the process of developing a successful succession plan?
Marshall: The first step should be to develop a transfer strategy. Think about your business and decide which is the best strategy for you:
- Transfer to a family member. Do you have family members already working in the business? Do they have the skill-set and work ethic to run the business? Can they afford to buy the business? How can you treat family ‘outsiders’ (often children not working in the business) fairly?
- Transfer to key employees. Do you have key employees in the business with both the skills and financial wherewithal to take over in your absence? If not, can you train them in the skills they need? In many cases you’ll want to start with the sale of a small portion of ownership to both see how the key employees handle new responsibilities and give them the ability to afford the purchase.
- Transfer to a third party. How would a sale to a third-party impact current employees? Have you maintained your financial books and records in such a way as to provide maximum value for your company?
Each course of action requires different considerations, but there are many common threads. In each case you’ll need to determine both fair market value of the business and, in some cases, what an appropriate discount might be (for family members or key employees). The strategy you choose will help set the course for the process that needs to take place for a successful transition.
Stewart: How does a business owner know when the time is right to sell or transfer their business?
Marshall: It’s never too early to begin developing your succession plan. Every business owner should have a “I’m suddenly not here…here’s what should happen” plan that covers premature death or disability. Do this planning first then begin to lay out your optimum long-term strategy.
Because most successful business owners are wrapped up in the day-to-day activities of running the business, we advise putting together an experienced team of professionals that could include a Certified Financial Planner™, CPA, and attorney to assist you. These financial experts will be able to assess:
- Where the business owner stands in terms of meeting personal financial goals.
- The overall market environment and risks associated with different courses of action.
- The timeline and tax consequences of a particular strategy.
Thanks, Marshall. Yep. We all think we are Superman and indestructible but, in my experience, the businesses that create the most lasting value and survive multiple generations are the ones where the founding entrepreneur and his or her successors had the foresight to plan for an effective transition.
On a personal level, I struggled the first few years after starting my business as I treated my business checkbook as if it were also my personal checkbook…paying personal expenses from my business account as necessary and, in effect, paying myself ‘whatever was left over’. Then someone gave me some very wise advice: “Treat your business as if it were a Fortune 500 company.” I immediately made changes to isolate all business expenses and revenues; pay myself a salary; built a written business plan with detailed annual budgets and multi-year projections; and began producing monthly financial reports that were reviewed against budgets. I also put together an elite team of professional advisors including CPAs, attorneys and bankers. Years later, once my company was firmly established, I developed a succession plan. This has made all the difference in the success of my business and my business continuation plan. I highly recommend any business owner do the same.