• Succession planning should begin well in advance of retirement to prepare for emergencies, facilitate smooth leadership transitions, and avoid rushed decisions under pressure.
  • Owners may choose from several succession pathways — third-party sales, family transfers, management buyouts, or employee stock ownership plans (ESOPs) — each with distinct benefits and challenges.
  • A strong succession plan includes business valuation, leadership development, legal and financial structuring, tax planning, and clear communication with stakeholders.

Only 20 to 30% of business owners who want to sell their companies do so successfully, leaving up to 80% without a clear path to harvest their wealth.[1] Their family or heirs might be forced to sell the business under duress and be shortchanged on the value of the company they've built.

A well-orchestrated succession plan ensures business continuity and preserves value. Besides easing owner transitions and securing your legacy, succession planning helps protect jobs, maintain client confidence, preserve business value, and manage tax exposure. This article reviews the key components of a solid succession plan, the financial tools for supporting a smooth transition, and how a trusted banking partner may help protect your legacy and set your company up for long-term success.

When To Start Your Succession Planning

Many business owners make the mistake of planning for their succession only when nearing retirement. However, succession planning isn't just about retirement. It should also prepare your company for various scenarios, including unexpected emergencies (e.g., personal health challenges or economic downturns) or strategic opportunities, like an early buyout. It ensures continuity for employees, clients, and supplies, so that they're not left in limbo if leadership changes.

You should start your succession planning as soon as possible, before you think you need it. Having a solid foundation allows you to groom successors and evolve your succession plan as circumstances change, so you don't make rash decisions under pressure.

“No one plans for the day a death, disability, or even divorce will turn a business upside down," says Eido Walny, founder of the Walny Legal Group, an estate planning boutique law firm in Milwaukee. “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 accidentally partnered with someone's ex-spouse or even their children."[2]

Succession Pathways for Small Business Owners

There are several common succession pathways for small business owners. Here's an overview of their pros and cons:

  • Selling to a third-party buyer, such as another entrepreneur, private equity firm, or strategic acquirer. This route often generates the highest sales price. However, it may take longer to find the right buyer, and you should be aware of cultural misalignments that could impact employees and customers.
  • Transitioning to a family member or heir. This pathway is best for preserving family legacy and may offer tax advantages with proper structuring. However, you should consider potential family conflicts and the possibility that successors may not have the interest or skills to run the company.
  • Selling to existing partners or the management team. Transitioning to trusted leaders within the company increases the chances of a smooth transition since the buyers already understand the business's culture and operations. However, financing may be more challenging without outside capital.
  • Creating an employee stock ownership plan. This method enables you to sell the company to employees through a trust funded by company profits. It motivates employees and fosters loyalty while offering favorable tax treatment for you. However, setup may be complex and costly without the right advice.

Key Components of a Succession Plan

A solid succession plan goes beyond stating who will run the business after your departure. This structured roadmap should protect value, minimize disruption, and ensure a smooth handoff. Here are the key components to include:

Busines Valuation

Work with a professional to assess the value of your company's assets, cash flow, and growth potential. Also, address buyers' priorities, including recurring revenue, digital capabilities, market trends, and operational resilience. 

Leadership Transition

Consider how you will identify, train, and mentor your successor and their leadership team. This process takes time, but it's worth the investment as it helps ensure business continuity.  

Legal and Financial Structuring

Implement the appropriate ownership, buy-sell, and shareholder/partnership agreements to protect your interests. Perform estate and tax planning and set up a durable power of attorney to cover the bases.

Tax Efficiency vs. Valuation

Most businesses maximize deductible expenses and minimize profits during normal times for tax efficiency. However, this strategy may backfire when you try to sell the company because the lower profit statements prevent an outside buyer from making an offer for the business's true value.

"Buyers look at historical financials. Effective succession planning means that a business owner will stop running the business for tax efficiency and start running it for maximum value, even if it means higher taxes," says Walny. "It takes time to work up the historical financials. That's why succession planning should start well in advance."

Timeline and Milestones

Include a specific timeline with actionable milestones in your succession plan. For example, indicate when the successor will assume more responsibilities, when they will secure financing, and when the ownership transfer will happen. 

Communication Plan

Outline how and when you will inform employees, clients, suppliers, lenders, and other stakeholders about the transition to maintain transparency and build confidence.

Financial Considerations in Succession Planning

Careful financial preparation is essential for a smooth transition. Here's what to consider in your succession plan:

  • Funding a buyout. Family members, partners, or key managers often need financing to purchase a business. Bank financing, including term loans or SBA-backed ones, may help internal buyers without draining company resources. 
  • Managing tax implications. Succession may trigger significant tax events for buyers and sellers, potentially eroding the sale's value. Consider tax-efficient structures, such as installment sales, trusts, or ESOPs, to reduce the tax burden. 
  • Preparing the business financially. A company with clean financial statements, strong cash flows, and reduced debts is more attractive to buyers and lenders. Your plan should streamline operations, diversify revenue streams, and ensure accurate and transparent financial reporting.
  • Creating liquidity without harming operations. While you may need liquidity from the sale to fund retirement or new ventures, withdrawing too much cash too quickly may weaken the company. Instead, consider staged buyouts, earn-outs, or seller financing to strike the right balance.

How a Trusted Banking Professional May Support Your Succession Planning

Having the right funding at the right time is critical to a smooth ownership transition. An experienced banking professional that understands the needs of small businesses may help you navigate this process with the right tools and services. For example, PNC offers access to dedicated business banking and succession planning professionals to guide you through the nuances of structuring your business and financing, maximizing gains while minimizing risks.

Your dedicated banker may advise you on SBA and term loans to help fund internal buyouts or external acquisitions, reducing the financial impact on the company's day-to-day operations. You may access treasury and cash flow management solutions to help optimize your company's financial health, making it more attractive to buyers. Additionally, your banking partner may provide valuation resources to help you set realistic expectations and improve your position in a negotiation. 

Start Your Succession Planning Today

Succession planning should not be a task you put off for "someday." Unexpected changes or new opportunities may mean the transition could happen sooner than you anticipate. The good news is that the process doesn't have to be overwhelming. Starting early, identifying the succession pathway, implementing the appropriate financial and legal structures, and getting access to the right financial advice and tools will help protect your business's value and your legacy.

At PNC, we support small business owners with advice, term loan solutions, and treasury tools. Let us help you design a transition strategy that supports your financial goals and sets your business up for future success. Learn more about our business succession planning solutions and book a meeting with a dedicated business banker to discuss your plan.