The term succession planning refers to a business strategy companies use to pass leadership roles down to another employee or group of employees.

Succession planning ensures that businesses continue to run smoothly and without interruption, after important people move on to new opportunities, retire, or pass away. It can also provide a liquidity event, which enables the transfer of ownership in a going concern to rising employees. Succession planning is a good way for companies to ensure that businesses are fully prepared to promote and advance all employees—not just those who are at the management or executive levels.

Understanding Succession Planning

Succession planning is a contingency plan. It is not a one-time event. Rather, it should be reevaluated and updated each year or as changes dictate within the company. As such, it evaluates each leader’s skills, identifying potential replacements within and outside the company and, in the case of internal replacements, training those employees so they’re prepared to assume control.

In large companies, the board of directors typically oversees succession planning in addition to the chief executive officer (CEO), and it affects owners, employees, as well as shareholders. A larger business may train mid-level employees to one day take over higher-level positions. For small businesses and family-owned companies, succession planning often means training the next generation to take over the business.

The process takes a lot of time and effort. As such, it requires:

Recruitment or Proper Hiring: The goal is to choose candidates who are capable of rising through the ranks in the future. For example, an experienced person from another company might be courted and groomed for a higher position.

Training: This includes the development of skills, company knowledge, and certifications. The training might include having employees cross-train and shadow various positions or jobs in all the major departments. This process can help the person become well-rounded and understand the business on a granular level. Also, the cross-training process can help identify the employees that are not up to the task of developing multiple skill sets needed to run the company.

Businesses may want to create more than one type of succession plan. An emergency succession plan is put in place when a key leader needs to be replaced unexpectedly. A long-term succession plan, on the other hand, helps the company account for anticipated changes in leadership.

There are five common ways to transfer ownership of your business:

  1. Co-owner: Selling your shares or ownership interests to a co-owner.
  2. Heir: Passing ownership interests to a family member.
  3. Key employee: Selling your business to a key employee.
  4. Outside party: Selling your business to an entrepreneur outside your organization.
  5. Company: For a business with multiple owners, you can sell your ownership interests back to the company, then distribute them to the remaining owners.

A sixth way to sell your business involves an ESOP and ESOP’s carry significant tax advantages as well as employee retention powers. They are complicated to do, however  an ESOP can be a tool to enable the owners of a family business to cash out and remove themselves from the business, in whole or in part, while rewarding their employees with full or partial ownership of the business—and keep the company independent.

Below is a typical checklist that can be found in books, and online.  We agree with the steps because it helps you see an end-to-end set of activities necessary to move forward towards sale and perhaps retirement.

  1. Get Started

Identify the need for a succession plan.

  • Determine the importance of family involvement in leadership and ownership of the company.
  • Establish personal retirement goals and cash flow needs.
  • Identify family members’ goals.
  • Determine the need for an outside facilitator.
  • Establish team of professional advisors (attorney, CPA, bankers, financial advisors, insurance specialist).
  1. Planning and Communication

  • Involve family members in the decision-making process.
  • Establish a method for dispute resolution.
  • Document the succession plan in writing.
  • Communicate your succession plan to family/stakeholders.
  1. Successors

  • Identify your successors – both managers of the company and owners of the business.
  • Identify active and non-active roles for all family members.
  • Identify required training for the successor(s).
    Provide necessary training to the successor to ensure the future of the business.
  • Will the retiring owner remain involved in the business? If so, define the role.
  • Provide counsel and support to successors.
  1. Estate Planning

  • Address taxation implications to the owner/business upon sale or transfer of ownership.
  • Does your estate have enough liquidity to pay for estate taxes?
  • Have you considered a buy sell agreement?
  • Develop estate and personal financial plan for owner, spouse and succeeding generation.
  • Provide for active and non-active family members (consider providing non-dealer related assets to non-active family members). Will non-active family members receive an equitable share of assets?
  1. Consider the Transfer Methods and Corporate Structure

Various options should be generated and considered to address as many family and business needs as possible. At a minimum, one needs to consider the following and document your conclusion:

  • Method of transfer may include outright purchase, gift/bequest, or a combination thereon.
  • If the business is to be purchased, financing options need to be considered, including financing from an external party or will the previous owner hold the loan.
  • If the business will be purchased, ensure the business can generate adequate after-tax cash flows to support debt and interest payments.
  • Tax strategies and implications.
  • Legal implications.
  • Business structure options (e.g. sole proprietorship, partnership, corporation, etc.)
  • Business agreements.
  • Insurance needs (health, life, disability, etc.) have been considered.
  1. Contingency and Risk Planning

  • Identify potential problem areas.
  • Dispute/conflict resolution mechanisms have been considered and addressed in business agreements.
  • Develop “what if” scenarios including action plans (including possible disability of yourself and your successor).
  • Do you have a plan in case you become permanently disabled?
  1. Business valuation

  • Obtain appraisal to determine fair market value of business and real estate.
  1. Exit Strategy

  • Determine method of transfer.
  • Establish a timeline for implementation of the succession plan.
  • Publish the plan so that affected individuals are aware.
  • Communicate regularly with all affected parties.
  1. Implementation / Follow-Up

  • A timetable has been established and is being followed.
  • Review the plan on a regular basis and update as necessary.
  1. Document maintenance

At a minimum, the following current documents are maintained in a file:

  • Legal will.
  • Power of attorney(s).
  • Property deeds/titles, leases, rental agreements, etc.
  • Mortgages and notes payable.
  • Tax returns, financial records, and financial statements for last five years.
  • Bank, brokerage, savings, and retirement account information.
  • Contact listing of all professional service advisors.

Contact Manex for more information.  Our focus is on small to medium manufacturers in Northern California.

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