Business Succession Planning

If there’s one thing that’s certain, it’s life’s uncertainty. While we all hope for the best, as a business owner, it’s important to be prepared for anything. Having an answer to life’s curveballs can help you stay in business, ensure that your legacy lives on, and that your business partners and family are taken care of.

It may surprise you to learn that 80% of business owners have no written company transition plan. Even worse, 43% have done no planning at all, according to the 2019 Exit Planning Institute State of Owner Readiness Survey for Wisconsin. Many businesses are founded on a high degree of personal trust and loyalty, often a simple handshake agreement.  However, these informal agreements are not enough to protect you against disagreements and damaged relationships—and can be a costly mistake.

Why are so many business owners unprepared? Many find it uncomfortable or daunting to have a discussion about succession planning or enacting formal agreements. Others fail to understand the importance of such discussions. And in other cases, it can even be seen as a sign of disloyalty.

The good news is that if you handle this process the right way, with respect for everyone’s point of view and a willingness to listen, partnerships can be strengthened and fortified. In the end, you should come away from the discussion fully confident that everyone’s interests are secured. This allows you to focus on your business instead of being distracted by unspoken concerns.

Asking the Uncomfortable Questions

Starting on the path to succession planning means pondering difficult, uncomfortable questions, like:

• What if your business partner became incapacitated or died? What would it mean to you if tomorrow you were in business with your partner’s spouse or children?
• If you were to pass away suddenly, what would happen to the equity in your business? Could it be extracted to support your family? What impact would this have on your business partner and his or her family?
• What if your business partner decides to retire and wants to sell their share of equity in the business? Do you have input about or control over who buys equity in the business?
• What would happen to your family if you were disabled and could no longer perform your expected business functions? What would happen if your partners did not have the cash on hand to buy out your equity?

These questions represent scenarios in which business owners were caught off guard and unprepared in considering unforeseen circumstances. Having a formal contingency plan will help ensure that your business and family are protected.

Protection for Everyone

There are several practical measures that can be put in place to protect you and your business partners’ interests. For instance, if your business partner were to unexpectedly pass away, you may feel an obligation to provide for their family.

But what if there wasn’t cash on hand to buy out your partner’s equity and provide a lump sum to his or her loved ones? What would you do? Would you try to liquidate your business to meet this obligation? What would this mean to your net interests?

With the right purchase agreements and insurance products in place, this becomes far less of a concern. Proper planning can ensure that the partner’s family will be provided for, while allowing the remaining owners to focus on running the company.

Specifically, business owners should consider:

• Shareholder agreement (corporations), partnership agreement (partnerships) or operating agreement (limited liability companies). These establish a plan for managerial succession and instructions on what happens to your interest in the business in the event of death, disability or retirement.
• Buy-sell agreement. This is a formal agreement for selling your interest in the business to an existing partner, family members or a third-party buyer.
• Business valuation. This enables you to transfer your business interest by gifting or sale, but the valuation should be prepared carefully before making any transfers to family members to avoid potential IRS challenges regarding valuation.

Strong Leadership in the Face of Uncertainty

Talking about succession planning—giving up control—is the bane of any passionate entrepreneur.

Passionate entrepreneurs who love what they do often hate to talk about succession planning. But it is inevitable that you and your partners will not own your business forever. This is why it’s so important to put a plan in place now for leadership, decision rights and the strategic vision for the business. This matters for two reasons:

• The transfer of leadership responsibility is a key driver in liquidity events. Business owners typically sign earn-out agreements that span from twelve to thirty-six months, helping ensure a smooth transition to new company leaders. Leadership transition could have a big impact on how much wealth you realize from the business sale. Having the right plan in place leads to better outcomes.
• There are scenarios in which it makes sense to separate decision rights from ownership. For instance, if one partner dies and his or her child wants to take over the business, what happens next? If the successor is not experienced enough to run the business but insists on doing so, what recourse does the remaining partner have? A formalized plan of ownership succession allows the business to continue uninterrupted and without disagreement.

Clarity for the Future

Formal contingency plans help business partners clarify their vision for the future. We all get so busy with our lives, families, and work that we often don’t think about the impact of events that may be outside of our control. But these conversations help us think clearly about what we want in the future and what it will take to get there.

If the process is handled correctly, guided by the right advisors, the end result should be peace of mind and a higher degree of protection for partners and their families.

Learn more about succession planning.