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5 Questions to Ask When Planning Business Succession

Many owners of small and mid-sized businesses dream of the day when they will reap the rewards of decades of hard work by cashing in and selling their business. For many of them, proceeds from a business sale will provide the bulk of their retirement income.

Given this, you might assume that the vast majority of owners have a formal business succession plan in place. However, this doesn’t appear to be the case. Just 58% of business owners say they have any kind of business succession plan in place, according to a 2019 survey conducted by PricewaterhouseCoopers. Among those who do have a succession plan, most of the plans are informal.

Start the Planning Process

If you own a business, it’s critical to start the process of succession planning if you haven’t done so yet. This is true even if you don’t plan to sell the business for many years down the road. In fact, many experts recommend that the succession planning process should start at least three to five years before your target date for a sale. This will allow time to get the business ready for sale, find the right buyer and prepare for the transition to new ownership.

Here are five questions to consider as you begin the business succession process.

  1. What kind of buyer do you want to sell to? You can sell your business to an outside or third-party buyer or to an insider buyer, such as family members, a group of managers via a managed buyout (MBO) or your employees via an employee stock ownership plan (ESOP). Among outside buyers, you can sell to a competitor — this is known as a horizontal sale — or another business along the supply chain, which is known as a vertical sale.

 

The kind of buyer you sell to will drive many decisions about succession, including how you set a price for the business, how the purchase is financed and how the transition to new ownership occurs. For example, you might set a lower price for the business and provide more flexible payment terms if selling to an internal buyer such as family members or employees than you would if selling to an outside buyer. 

  1. What are your post-sale goals? Do you plan to retire, relax and travel after you sell your business? Or do you want to scratch an entrepreneurial itch and start another venture? Maybe you want to stay involved with the company in more of a consultative, non-ownership role, or perhaps you’d like to spend time on charitable and philanthropic endeavors?

 

The answers to these questions will also drive many succession decisions. If you plan to retire, for example, you will need to set up a plan to ensure that the proceeds from the sale of the business will be enough to fund your desired retirement lifestyle. Or if you want to start another business, you should ensure that the sale proceeds will be sufficient to fund your new startup venture.

  1. What is your business worth? This is the proverbial $64,000 question. Many owners think they have a good idea of what their business is worth, but they’re often too close to the situation to look at business value objectively. For example, owners tend to over-value the “sweat equity” they’ve put into the business by working 60- or 70-hour weeks (or longer) for decades.

 

The best way to gauge the value of your business is to hire a professional business valuator to perform a formal business valuation. This professional will look at a wide range of factors to come up with an objective business value that’s untainted by bias or emotion. These include such factors as the business’ financial condition, projected future earnings and cash flow, management team strength and the industry in which you do business.

  1. How will you best position your business for sale? The years leading up to the sale of your company will be critical when it comes to boosting the value and potential sale price of the business. During this time, you should be making financial and management decisions based mainly on how they will position the company in the eyes of potential buyers in the near-term future — not how you can lower current income taxes and accomplish other short-term financial goals.

 

In particular, you should focus on a number of different value drivers that will help boost the eventual business sale price. These include ensuring financial statement quality and accounting process integrity, building management team depth and strength, strengthening competitive advantages, reducing customer concentrations and broadening business growth opportunities.

  1. Who will be on your advisory team? It takes a strong team of experts and specialists to execute a successful business sale and transition. Therefore, you should start thinking about who will be on your team long before you’re ready to exit the business.

 

A business succession advisory team usually includes an investment banker or business broker, accountant, legal counsel and financial advisor. Choose an attorney, accountant and financial advisor who specializes in the intricacies of business succession, sale and transition. This includes in-depth knowledge of purchase and sale agreements, tax minimization and other details involved in succession planning.

How We Can Help

We can help you start the process of succession planning and devise a formal business succession plan that accomplishes all of your objectives. Give us a call if you’d like to schedule a meeting where we can get the process started.

 

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC’s (“Frontier”) investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.