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6 minute read

A Guide to Succession Planning for Small Businesses

Are you a small business owner? Then you should consider a succession plan. Learn how to create a small business succession plan with this guide.

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

Growing your own small business is often likened to having a child. As a small business owner, you are the sole person responsible for starting, cultivating, and scaling the business. It also means that you have a strong incentive to protect your business. With that said, have you implemented your small business succession plan? Trust & Will explains what a succession plan is, and why it is critically important for a small business to have in place.

What is a small business succession plan?

A small business succession plan is a plan that outlines what should happen to your business should you retire, pass away, or become incapacitated. The document should include details as to whom your business will transfer to, how, and when. 

Many succession plans include plans for buy-sell agreements when the small business owner does not have a family member to take over the business. The agreement in this case can be secured financially by a life insurance plan or a loan. Unless the business is going to be passed to an heir through the owner’s estate plan, then it is often sold to a co-owner, an employee, or an outside entity.

What happens to a small business when the owner dies?

As a small business owner, your business succession plan is closely tied in with your estate plan. This is because your personal share in the business (which may be 100 percent if you are the sole owner) are a part of your personal estate. This business interest can be included in your Will, Trust, and other estate planning documents and can be left to an heir or heirs of your choosing. 

Now, it’s important to draw a distinction here between business ownership interest and business operations. Your estate plan may address what should happen to your business interest when you pass away, but it does not necessarily dictate what should happen to the business and its operations. This is where the small business succession plan comes in.

Why should the small business owner have a succession plan?

A small business owner who cares about the future of their business, and what should happen to it when they pass away, should strive to put a succession plan in place as soon as possible. If anything were to happen to them, the plan will go into effect and can help minimize the negative effects of their departure. 

This “departure” doesn’t necessarily always mean death or retirement. It can also be a temporary incapacitation such as an illness, or getting stranded in a foreign country, that would bar the owner from managing the business themselves for a short or long duration of time. By having a plan in place, the appointed successor would have the means necessary to take over and manage operations without interruption. This can help the business avoid any breaks in service or production and thus retain clients.

Here are some other key points that can be addressed in a succession plan:

  • To liquidate or not to liquidate: If you were to pass away or retire, would you want the business to continue? Some owners simply want to liquidate assets and close the business. They can pass the proceeds to their heir(s). Others might want the legacy of their business to continue long after they’re gone. If you choose the latter, you’ll need to choose a successor.

  • Successorship: A successor is the individual who will take over the owner’s place. This can be a family member, a key employee, or other individual. Not only is it important to designate the successor, you’ll be glad you planned in advance so that you can groom them, provide guidance, and ensure they have the tools and skills necessary to lead the business. This can have positive ripple effects, such as ensuring employees feel secure regarding the future of the company and their employment.

  • Debt management: Most business owners have loans and lines of credit to think about. When the owner passes away, the lending institutions have the right to force repayment of the loans. A solid succession plan should include instructions for how to manage debt, such as what funds or assets should be used to repay loans.

  • Tax planning: Last but not least, a crafty small business succession plan can also minimize the impact of taxes. For instance, the owner could take advantage of the Tax Relief Act or gift-giving exemptions to help reduce the owner’s tax liability. 

How many small businesses have a succession plan?

According to Business Wire, seventy percent of business owners have a succession plan. However, half of the owners belonging to this group have concerns about their selected successor’s ability to grow the business long-term. Over half are concerned that this planned succession could result in family in-fighting.

This data tells us that simply putting a succession plan in place isn’t always enough. There needs to be a strong strategy in place that can help ensure a smooth transition. This might look like swift and effective liquidity events, keeping knowledge retained within the business, or ensuring continuity in a manner that avoids conflict within the family. A strong succession plan can take a long time to develop and fine-tune, which means that business owners should not procrastinate on this critical process.

Options for small business succession planning

Now you should have an understanding of what a small business succession plan is, and why it is so critical for the owner of a small business to implement. With that said, you may be wondering what your succession plan options actually are.

Here is an overview of some of your small business succession planning options.

Will or Trust

When it comes to a business you own, you need to approach your ownership interest from two different lenses: estate planning and succession planning. Your ownership interest is your personal property. This means that you have the option of using a Will or Trust to bequeath your personal interest shares to an heir or heirs of your choosing. 

However, note that the way you structure your estate plan may or may not coincide with your succession plan.

For instance, one person could inherit both your business interest and your role as President of the business. In another instance, your heir could inherit your business ownership but play no role in the active management or operation of your business. 

You could also direct in your succession plan that your business is sold should you pass away, and instruct in your estate plan that your heir inherits the proceeds.

Operating agreement

An operating agreement is a legally-binding document typically used when multiple owners form a company. The agreement addresses who the owners are and how the company is managed, including financial and operational rules and provisions. 

From a succession planning perspective, the operating agreement should address items such as who should take over duties on a temporary basis, how long-term decisions are made if one of the owners are absent, and whether the surviving owners should buy out the deceased owner’s business interest.

Sale during life

Also know that you don’t necessarily need to wait until retirement, or worse, an unexpected incident to do something about your ownership interest. You can sell all or most of your ownership interest to a third party and take a reduced role in your company.

This gives you the ability to start the leadership transition while you are still on board as a manager or advisory member to provide your advice and wisdom. 

Buy-sell agreement

A buy-sell agreement is a pre-agreed upon sale between an owner and a third party. The sale is triggered by the death of the current owner, or other type of event. This trigger event causes the ownership interest to be transferred to the third party. The price is agreed upon at the time of signing; it could be a fixed price or based on another valuation method such as fair market value. 

Employee handbook + organizational chart

When it comes to succession planning, proper documentation is vital. When you’re working with a small team that knows the ins and outs of your business, it’s easy to skip over foundational tasks such as creating an employee handbook or organizational charts. Leave that to the corporations!

However, these formalities are essential to ensuring smooth operations during a time of transition. Other documents to include include a list of key roles and their job duties, including key tasks and what that role is responsible for in the organization. If one of these roles are suddenly vacated, then the successor can take the document and be informed on what responsibilities they need to assume. 

What should succession planning for a small business include?

A business succession plan is usually represented by a collection of different documents. Each document in the collection is created with the intention of achieving a certain outcome. Some documents may be for information or education purposes only, while others may be legally binding. 

While no two small business succession plans may look the same, here is an overview of what a small business might include in their succession plan:

  • Succession timeline: Define the timeline under which the succession should take place. This could be a predetermined date, or in certain cases of trigger events such as your death, disability or retirement.

  • Identify your successor: Naming your successor is an easy decision if you have one family member who is involved in your business and wants to take over. However, this task can be harder when you don’t have a family member successor or work with a team of co-owners. Your successor could be your fellow co-owner, or a key employee that you identify. A successor can also be a third party entity that you sell your business interest to.

  • Include clear succession instructions: Be clear about who will take over the business and how your other heirs will be compensated. Any instructions regarding your personal net worth should be done through your estate plan, such as your Will or Trust.

  • Formalize your SOPs: Be sure to finish documenting your standard operating procedures (SOPs), which is essentially a guidebook to how your business is run. Be sure to include an organizational chart, operations manual, employee handbook, job descriptions, trainings, and critical meetings and processes.

  • Value your business: If you plan to sell your business, or allow your heirs to sell your business shares, then you’ll need to know the value of your business. This is a best practice regardless of succession planning, so it’s great to do anyway. There are many different methods to valuing a method. Be sure to document what method should be used to value your business and ensure your business value is calculated, documented, and updated regularly.

  • Fund your succession plan: Business transfers and sales require funding. It is extremely helpful if you lay out in advance how your succession plan should be funded. Ideas include a life insurance policy, a business loan, or seller financing.

Get some help creating your small business succession plan with Trust & Will

If you’ve started your own business, don’t delay creating your small business succession plan. If anything were to happen to you, the lack of a succession plan can create serious negative consequences for your business. Many new business owners make the mistake of delaying creating a plan, thinking it’s something to take care of closer to retirement. What they don’t realize is that the succession plan can also go into effect at any age, such as during a serious illness or other emergency that can be temporary or long-term. If your priority is to preserve the value of your business, whether it be for yourself or your heirs, you should create your succession plan as soon as possible.

Note that your business succession plan should also be accompanied by your estate plan. This is because your estate plan will address what should happen to your personal business interest and shares, and how they can be passed down to your heirs. If you need any help setting up your Trust, Will, and succession plan, know that Trust & Will is here to help. Take our free quiz to see where you should get started, or compare our different estate planning and settlement  options today!

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