7 Steps for Creating a Smart Succession Plan

Most family businesses claim to have a succession plan in place, but many of those are informal, increasing the chance that a transition of business ownership might not go smoothly. Here are some tips to ensure a solid plan is in place.

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Many owners of both small and large family businesses are reluctant to undertake succession planning and end up doing so as a result of other personal planning. Whether the owner or owners are addressing their estate or their retirement, neither can be adequately structured without having made plans for what is most likely the owner’s largest asset, the family business. 

According to PwC’s 2019 U.S. Family Business Survey, 58% of family businesses report having succession plans. But most are informal, and only 18% claim to have robust plans in place.

The reluctance to plan is understandable given the number of emotional decisions that need to be made. An owner can't simply think about the future of the business. He or she also needs to consider personal involvement and the potential involvement of other family members. Is there a time the owner plans to step back and cede responsibility to others? If so, who are those “others?” What happens to the business if the owner dies or becomes disabled? Is there a plan to eventually sell the business? Are there plans for key personnel — including for those who are nonfamily members — for not only instances of death or disability, but also to retain and reward?

The process of creating and implementing a business succession plan often means having honest and sometimes brutal discussions with other family members (and employees). For example, imagine having to tell a son or daughter who has struggled working in the business that he or she is not fit to take over. It's no wonder so few family businesses have followed through on a formal plan, which involves not only a written strategy, but also the ability to fund all the liabilities uncovered to make sure the future vision for the business is realized and not knocked off course.

Approaching succession planning in distinct steps makes it clear to the business owner what needs to be accomplished. Here are seven steps for creating a formal succession and continuity plan for a family business.

1. Define the vision for the future of the company and an owner’s involvement.

An owner of a business must know where the business is headed. The plan might be as simple as shutting down the company someday, which, if the company is reliant upon the unique skills of the owner or the company is not readily transferable, may be the most realistic outcome.

The company could be transferred to the next generation or other family members. Or employees or outsiders could purchase the company.

Hand in hand with considering the disposition of the company is the need to understand the exit plan for an owner and what that means to continued operations.

2. Identify successors.

This doesn’t mean only identifying future owners. It also involves knowing who among the current employees could be a key manager or executive. Methods for training, retaining and rewarding will need to be implemented. If the current employee pool lacks leadership potential, a plan to recruit that talent should be a priority.

3. Plan for contingencies.

This means planning for “what-if” scenarios. What if an owner or other key employee dies or becomes disabled? What if a key employee leaves the company? What if an owner gets married or divorced or has other family members they want to have working for the company?

Closely linked to all these scenarios involving personnel are questions about the shares of the company that any of these individuals might hold and what happens to those shares.

4. Communicate the plan to others.

For a succession plan to be effective, it must be shared with those it impacts. Successors should know the opportunity ahead. Family and nonfamily members alike need to understand their roles with respect to the company. These conversations can often be difficult, and many companies bring in professional facilitators, often attorneys, to help.

“The more communication, the better,” says John Olivieri, a partner in the Indianapolis and New York offices of Barnes & Thornburg, whose practice focuses on estate and business succession planning. “In the absence of communication, family members will have expectations that may be unrealistic and can lead to disharmony and litigation. When everyone knows the plan, some may not be happy, but no one is surprised. As a result, a smoother succession can take place.”

5. Obtain an updated business valuation.

An independent appraisal to determine the fair market of the company is useful for both personal and business purposes. From a business perspective, the value to each owner is important for buy-sell and key-person provisions and for funding any liabilities that arise from having to apply those agreements. Personally, the business value enables the estate and retirement plans of an owner.

“When interest in a family business is to be transferred to the next generation, it may be necessary to start by reorganizing the capital structure of the company,” says Dan Rosio, the partner-in-charge of Katz, Sapper & Miller’s Valuation Services Group in Indianapolis. “This often involves classifying a small number of shares as controlling so that a majority of the shares, which are noncontrolling, can be gifted or sold to other family members. There are similar considerations for transfer or sale to nonfamily members.”

6. Formalize the plan by creating or updating supporting documentation.

This includes:

  • Shareholder agreements
  • Buy-sell agreements, including trust agreements where there are intrafamily transfers
  • Key-person agreements
  • Key-person compensation arrangements
  • Power of attorney(s)

In addition, the following records should be collected, well-organized and easily accessible when needed:

  • Legal will
  • Property deeds/titles, leases, rental agreements, etc.
  • Mortgages and notes payable
  • Tax returns, financial records and financial statements for the past five years
  • Bank account information
  • Contact listing of all professional service advisers
  • Life insurance and property and casualty policy information

7. Implement life insurance to fund identified liabilities arising from the succession plan.

Life insurance provides the liquidity to make good on promises made in various planning agreements at any time. Under a buy-sell agreement, funds are readily available to purchase the shares of a deceased owner. The same policy can also be used to provide additional proceeds to the family of the deceased owner. Many key-person executive compensation programs are funded with life insurance and include nonqualified deferred compensation plans, split-dollar arrangements and executive bonus agreements.

Additionally, life insurance can be useful to a business owner in order to equalize the disposition of the company. Where a business is left to one or more family members to the exclusion of others, life insurance can “equalize” not inheriting the family company. Learning a parent has selected another sibling other than you to own the business is easier to accept if the value of the company in cash can be expected.

The Bottom Line

Perhaps the most important thing a business owner should understand when faced with creating a succession plan is that the plan will not be set in stone. Just about any element of the plan can be changed as conditions demand. A company thought to be carried on for years and passed to children could suddenly be sold the next month if an attractive offer is made. Identified successors might turn out to not be a fit, while others thought to be lacking in leadership potential blossom. 

Changes should be expected and usually do not create complications as long as they are well documented and communicated. Often growth of a business creates imbalance in the succession plan. Agreements, valuations and life insurance funding can become obsolete in a company that is expecting growth. Most importantly, any liabilities impacted by changes to a succession plan should be evaluated along with the life insurance funding solution in place to see if existing coverage should be repositioned or if additional policies are needed.

About the Author

Mark Leyden is the CEO and founder of Mark Leyden & Associates, an Indianapolis-based firm specializing in assisting businesses and families in the acquisition and management of life insurance assets. He specializes in assisting business owners and families, including some members of the Forbes 400, in design and funding of wealth transfer and business succession plans.

This article was originally published by the Association of Equipment Manufacturers.  

AEM is the North American-based international trade group representing off-road equipment manufacturers and suppliers, with 950-plus companies and more than 200 product lines in the agriculture and construction-related sectors worldwide. AEM has an ownership stake in and manages several world-class exhibitions, including CONEXPO-CON/AGG.


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