Succession Planning for Small Businesses
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Unlike corporations, small businesses and partnerships without solid succession plans often fail when the owner or a senior-level partner retires, becomes incapacitated or dies. Problems also can arise when partners no longer get along and decide to part ways.
Proper succession planning is essential for family businesses in particular, which will have to either identify family members who are qualified for leadership positions or consider other contingencies beyond the family.
Planning early, basing decisions solely on business needs and revisiting the plan as conditions change are the keys to a successful hand-off. You may also benefit from the counsel of a skilled small business attorney.
Steps for Developing a Succession Plan
There are several different strategies and options for succession planning. The following five general steps for developing a plan provide a good road map for the process:
- Choose Your Successor - Start by looking within the organization, examining employees who may have the right leadership skills. Family businesses may benefit from impartial third-party consultants, given the emotional aspects of choosing among family members. This should begin at least 15 years prior to a planned retirement.
- Develop a Formal Training Program - First, identify critical functions of the company and then have your successor work in each of these areas. It's not enough for your successor to understand the executive duties alone, since he or she needs to understand the breadth and depth of the organization. You may also have to allow your successor to make some mistakes along the way.
- Set a Timetable - Determine how and when control of the company will be shifted to your successor. Ease your successor into the position and avoid the impulse to routinely overrule his or her decisions during this transition phase.
- Plan Your Own Retirement - This may not seem related, but it's important for departing officers to prepare for their departure and plan the next chapter of their lives. This also will make it easier for you to let go and for your successor to fully take the reins.
- Execute the Succession Plan - If you have made the proper preparations, this should be as simple as handing over the company and stepping aside. Businesses whose owners install their successor during their lifetime typically have a much smoother transition to the new principal.
Succession Planning Strategies
We usually think of a business owner simply handing over the reins to a new owner or principal when we think of succession planning. But there are several different financial options for business owners who would like their organization to survive beyond their own tenure. Below are six such strategies for succession planning:
- Selling Your Business Interest - You may choose to sell your business interest outright in return for cash or other assets. Most partners or company officers have the option of selling before they retire, at retirement, at death or at any time in between. You may have to pay capital gains tax if you sell before your death.
- Transferring Business Interest with Buy-Sell Agreement - This is a legal contract that arranges the sale of your business interest in advance, to be enacted at a predetermined event such as retirement, divorce, disability or death. The buyer is obligated to purchase your interest at fair market value at the time of the triggering event.
- Granter Retained Annuity Trusts or Unitrusts - GRATs and GRUTs are irrevocable trusts to which you transfer assets while still obtaining an income for a given period of time. At the end of this period or upon your death, the assets in the trust go to the other trust beneficiaries. This is considered to be a quite sophisticated succession tool.
- Private Annuities - This is the sale of property in exchange for regular payments to you for the rest of your life. Ownership of the business is transferred to family members or another buyer, who promises to make periodic payments until your death (and sometimes for the life of a surviving spouse). This allows you to avoid gift or estate taxes.
- Self-Canceling Installment Notes - SCINs allow owners to transfer a business to a buyer in exchange for a promissory note, requiring the buyer to make a series of payments. The remaining payments are canceled upon the seller's death.
- Family Limited Partnerships - This can help when transferring business interests to family members. You first establish a partnership with general and limited partnership interests, then transfer the business to the partnership. Over time, you may gift your business interest to family members.
Legal Help with Small Business Succession Planning
With the many options available to your business, you'll want a legal expert to help you establish a plan and reduce your business's tax burden. Speak to a business and commercial law attorney to learn how you can utilize succession planning tools and options.