Small businesses make up a significant portion of the United States economy. According to the U.S. Small Business Administration, they represent 99.7 percent of U.S. employer firms and 64 percent of new private-sector jobs. However, when small businesses are owned by family, it can create complications when planning for a company's future. While many small business owners may be reluctant to hand over control of their business, having a succession plan is key to its future success.
The Importance of Succession Planning
Business owners need to plan ahead and have an exit strategy for what happens to their business after they retire, or if they encounter unfortunate worst-case scenarios such as severe illness, disability, or death. Without a good succession plan, your family or other heirs might be forced to sell the company under duress and be shortchanged on the value of the business you've built. If there's no clear plan in place for who's in charge of the company, your business might end up directionless and at risk for failure.
Building a successful small business is the work of a lifetime. Make sure that your legacy is secure — and your finances and family are protected — by creating a solid succession plan to decide how to manage, sell, or pass on your business to a new generation of ownership.
We talked with an expert in small business succession planning to find out more about what small business owners need to do starting now to secure their futures.
When to Get Started
As a small business owner, you're often focused on what's happening today, and might be reluctant to grapple with the emotional decisions related to succession planning, such as who to name as the CEO's successor and which family members or employees to sell the company to. But it's important to have these conversations and work through the emotions now, when you have time and flexibility to make careful decisions, rather than put your family and heirs in an emergency situation down the line.
“Statistics bear out that 60-70 percent of small business owners wish to pass along their businesses to the next generation of family members, yet only about 15 percent ever do that," says Eido Walny, founder of the Walny Legal Group, an estate planning boutique law firm in Milwaukee. “The key to understanding that massive disconnect is in the lack of business succession planning. Business succession can't be founded on a wish. Handing over keys one morning is not a plan. There is a lot that needs to be thought through, and the facts bear out that very few business owners give enough thought to succession planning."
Walny says that the worst situation that happens from a lack of business succession planning is when the owner has a medical emergency.
“No one plans for the day a death or disability or even divorce will turn a business upside down," Walny says. “So the best time to plan for those events is well before they become a reality. That is especially true if there are multiple owners in the business. You want to plan so that you are not accidental partners with someone's ex-spouse or even their children."
So when is the right time to start? "At startup. If not then, the second choice is right now. Get a succession plan in place. You'll be happy to have it when you need it eventually. But that time could be tomorrow," says Walny.
Pay Attention to Tax Efficiency
One challenge for business succession planning is that it requires the business owners to adopt a different strategy for running their businesses. For most businesses during normal operations, they try to operate as tax-efficiently as possible by maximizing deductible expenses and minimizing profits. However, this strategy can backfire during the lead-up to selling the business. If you're planning to sell in a few years, it's worthwhile to adjust your tax planning strategy to maximize the value of your business to prospective buyers.
“Most small businesses are run for tax efficiency, which usually means low profit statements," Walny says. “Any business owner knows that low profits does not mean the business is doing poorly. But low profits mean that an outside buyer will not make an offer for the full value — the true value — of the business. Buyers look at historical financials. As a result, good succession planning means that a business owner will stop running the business for tax efficiency and start running the business for maximum value, even if it means higher taxes.
"The results will be a much stronger offer from prospective buyers, even at the expense of tax dollars," Walny continues. "But it takes time to do that and work up the historical financials. So this is another reason why succession planning needs to be done well in advance."
Get Power of Attorney
Keep in mind it helps to put your wishes in writing ahead of time by using the durable power of attorney — a written document that lets you designate a trusted person to act on your behalf in case you become incapacitated by illness, accident, or disability.
A durable power of attorney lets you instruct who will manage and control your affairs while you are incapacitated. As part of making these advance directives for your financial affairs, you can also set up a comprehensive business plan to be enacted by your designated person with power of attorney, to include transfer of assets and business holdings into a newly formed business entity, if you so desire. The benefits include valuation of your business, tax considerations, asset protection, and preparing for the next phase of management.
Watch Out for Estate Taxes
Business succession planning is not only a matter of managing business operations and choosing an ideal CEO-of-the-future; it's also important from a tax planning standpoint.
Depending on the size of your business and the state where you live, estate tax can be an underrated issue for business succession planning.
Business succession planning touches on every vital issue that affects your business and personal finances: taxes, business operations, grooming the next generation of leaders for your company, and securing your family's financial future. It can be a complex and emotionally fraught topic, but it's essential to the future of your business and your family's well-being to have the tough conversations now and create a solid business succession plan.
All of these issues reinforce the importance of creating a business succession plan as soon as possible — but even "today" is not too late. Talk with a professional estate planning attorney, tax attorney, or other professional advisers to make sure your interests are protected — and that your company is ready for a prosperous future without you.