Some people believe that succession planning means planning retirement. But there are far more options available to you if you own a successful business. If you have built a business and wish to see it continue to thrive in the future, the business has to develop its own identity apart from the owner. That means you must give it a plan of its own.
Think of a succession plan not as just determining who will succeed you, but as a continuity plan— to be used in cases of both planned transitions and unexpected disruption. The purpose of succession planning is to evaluate the needs of your business in balance with your personal needs financially, socially, and professionally. In some cases, that can mean selling your business to a third party in the case of retirement.
John Warrillow, the founder of Value Builder System, and business author writes about something called “The Freedom Point,” which is when the net proceeds (i.e., after taxes and expenses) of selling his business would garner enough money for a business owner to live comfortably for the rest of their life. Your lifestyle determines your Freedom Point. However, it’s worth considering the risk you’re taking when you pass it.
If this pandemic has taught us anything, it is that nothing is for sure. A thriving business one day can turn into a struggling company overnight. When your business makes up most of your net worth and selling it would garner enough money to retire, there’s no financial reason to continue owning your business. You may enjoy the challenge, the social interactions, and the creative process of building a business, but keeping it may be unnecessarily risky.
When you’ve crested the Freedom Point and want to diversify — but still don’t want to retire — you have some options:
• Sell a Minority Stake: In a minority recapitalization, you sell less than half of your shares. Often sold to a financial investor such as a private equity group, a minority recapitalization allows you to diversify your net worth while continuing to control your business.
• Sell a Majority Stake: In a majority recapitalization, you sell more than half of your shares to an investor who will most likely ask you to continue to run your business for many years to come. You get to diversity your wealth, keep some equity in your business for when the investor sells, and continue to run your company.
• Earn-Out: When you sell your company, you’ll likely have to agree to a transition period of sorts. One of the most popular is called an earn-out, where you agree to continue to run your company as a division of your acquirer’s business for a specified period of time. Your earn-out may be as little as a year or as long as seven, but the average is three years. Therefore, if you’re past the Freedom Point and can see yourself wanting to step down in the next three to five years, an earn-out may be worth considering.
Small business owners should be planning business succession/continuation throughout the life of their business. Succession is an orderly transfer of business leadership ensuring the continuation of the business and benefit to the owner. But what about continuation of the business when tragedy strikes?
Part of your succession plan should be a contingency plan. This is a part of the succession plan that is activated in the case of an emergency such as death, disability, divorce, or other circumstances that require rapid and decisive action. Make sure that your plan answers these questions: who will manage the business until the owner returns or there is a formal transition? Is there an emergency buyer identified and a buy sell agreement in place? What is the disposition that you desire for your business and its assets? Contingency planning as a subset of succession planning that considers your heirs and the fate of your business in your absence.
Create a succession plan as soon as possible and review it at least once a year to make sure that it is consistent with your personal financial plan, changing tax laws or the legal landscape.
If the process seems a little overwhelming to you, you are not alone. Having someone there to guide you through the planning and execution phases can help you achieve the clarity and confidence you need to move forward. Involve trusted partners including a Certified Exit Planning Advisor or business intermediary, who will work with your financial planner, tax accountant and if necessary, lawyer, to ensure that you are leaving the legacy that you envision.
Kathryn Guthrie is an owner/broker of the Liberty Group of Nevada. For more information, call 775-825-3948 or visit www.thelibertygroupofnevada.com.
