What is Succession Planning: Everything You Need to Know


Author: Ryan Serrecchia 



It takes a forward-looking individual to launch and build a small business—someone with a rock-solid commitment to investing time and money in an organization based on its potential for future rewards. So it’s a bit ironic that, according to the Small Business Administration, only 30 percent of small-business owners have done any succession planning, let alone sought out succession planning services, a strategy that can contribute to the ultimate value of their company. Owners tend to be so focused on the day-to-day requirements of dealing with clients and employees that they barely have time to plan dinner, let alone plan for the long term. But failing to appreciate the importance of succession planning can have a number of negative consequences. Uncertainty about who will eventually assume control can lower the value of a firm, while also increasing stress and forcing the owners to work longer than desired or sell at a less favorable price and decreasing personal wealth.

Why Succession Planning is Important 

So what is a succession plan? And what are the succession planning best practices you should consider? And how will it affect your life, financial plan, and investment portfolio?

Essentially a succession plan can take one of three forms: an internal leadership transition, a sale of the business, or an ESOP (Employee Stock Ownership Program).

Leadership Transition

For many business founders, keeping the firm in the family, or at least in the hands of a chosen successor, is the instinctive first choice. Depending on the degree of authority that’s been delegated during the firm’s prior history, this may involve little more than acknowledging an individual who already knows the ropes, or it could require a lengthy grooming process to prepare someone for the full responsibilities of top management. The ability to keep passive income when a family member retains control of the company is a compelling consideration for some firms to construct a succession plan around the family tree.

When selecting and preparing a succession candidate, it’s important to recognize that succession planning is actually a process of ongoing management. It requires identifying areas in which a candidate will need development, and then managing that development by establishing goals that meet the widely recognized SMART criteria: Specific, Measurable, Attainable, Realistic and Timely.

Of the three strategies, this requires the most foresight and preparation. And while the continued income is very attractive, it does not guarantee complete peace of mind in retirement. Small businesses may be a riskier asset than traditional investments—so we’d recommend creating a financial plan beforehand to make sure you have a “plan b” if the business falters in the hands of new leadership.

Business Sale

Selling a business is also a common objective, especially for those who do not have family members available or interested in succeeding the founder. In this case, the two primary considerations are the value of the business and the nature of the potential buyers.

Regarding business value, the bottom line is how profitable your firm is likely to be once you’re no longer involved. Have you established processes that will continue to operate smoothly without you? Can the company continue to grow if you’re not driving new business development? Do you have a brand that will continue to add value going forward? Bear in mind that owners tend to overvalue their businesses, and it can be difficult but essential to realistically assess the return you’re likely to get for your years of effort.

As for potential business acquirers, you’ll want to understand the motivations of each potential buyer and position your firm accordingly. Is it a competitor primarily interested in your book of business? Is it a venture capitalist with the resources to buy your company and then invest in building up its value? Or is it a young entrepreneur able to secure a loan to help them use your company as the launching pad for the dream they plan to build?

Regardless, selling your business is the situation in which it’s most important to have a financial plan, as that will provide you projected dollar amounts needed for retirement or your next phase. If you don’t know how much you need in retirement, you won’t know when you have to walk away from the table. Financial planning can remove some gamesmanship in the negotiating process and provide you peace of mind when the deal does or does not close.

Employee Stock Ownership Plan (ESOP)

For business owners interested in planning a gradual exit from their firms, an Employee Stock Ownership Plan can be a practical choice. In this case, you’ll establish a trust into which you’ll make annual contributions of company shares, and/or cash the ESOP can use to buy shares. The trust typically allocates shares to the accounts of all full-time employees over the age of 21 based on their pay or another formula. When employees leave the company, they receive their stock and must be able to sell their shares back to the company at that time if a public market for them doesn’t exist.

If your company is profitable, you may have the ability to deduct stock and cash contributions to the ESOP trust from your taxes is a major benefit to your personal finances. And although the stock will carry voting rights, a board of directors will still guide the company and will need to be selected as part of your succession planning. A possible negative to an ESOP can be a potentially lower return than is likely from selling the company outright. This is because the ESOP cannot pay more than fair market value for shares, which must be determined by an independent valuation specialist if your stock isn’t publicly traded. Private companies also face the cost of purchasing shares from departing employees. That can be substantial if, for instance, many employees retire around the same time. In addition, ESOPs can cost tens of thousands of dollars to establish, at a minimum, and are only available to C- and S-corporations; partnerships as well as most professional corporations are ineligible.

Succession Planning Best Practices

What have those with experience in succession planning identified as essential considerations when preparing for the future of a company? Here, briefly outlined, are some of the most important steps to take.

Understand Your Long-Term Plan

If you haven’t documented your vision for the company, now is a good time to define that vision and put it in writing. Use the data available to you to project the challenges and opportunities your successors may face, and what it will take, in terms of management skills and resources, to address them.

You’ll also want to think about your long-term personal goals, and integrate that into the planning process. What do you want to do next? Do you want to retire? Start a new business? Volunteer? And how much will all of that cost? Answering these questions should give you increased clarity about the next phase of your life.

Recognize How Your Business Needs to Work

What physical processes and organizational relationships are essential to your company’s efficient operations? What core managerial and technical competencies must your succession team possess to ensure continued success, and support ongoing improvements?

Define Your Role, and Who Else Can Fill It

Consider the big picture as well as the details of your involvement with the company. What knowledge and experience will be required to make informed strategic decisions going forward? And what technical or specialized background will be essential to replace any hands-on aspects of your involvement—either by your direct successor or by others to whom they might delegate responsibilities?

Work with Outside Professionals

CERTIFIED FINANCIAL PLANNER™ - These professionals will be able to help you project what finances you need in retirement or the next stage of life. Plus, they understand how businesses affect personal finances and can help you prepare for the transition.

Certified Public Accountant (CPA) – If you’re a small business owner, you probably already have one. And that’s good as they’ll help with the accounting and tax implications of your business.

Investment Banker or Valuation Consultant – Often times, CPAs won’t actually draw up the valuations, so these professionals can provide the basis for determining the value of your company.

Corporate Attorney – This professional draws up the documentation and helps in the negotiation and terms of the succession agreement.

These professionals often become a repository of information on your company and can act as outside counsel when the new leadership comes in as well.

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Establish Succession Processes

Develop a systematic approach to succession that includes identifying those with required talent, either within the company or through recruitment, and ensuring the diverse development opportunities, such as training and lateral moves, needed to prepare them for greater responsibilities. Providing this increasing responsibility can be an important factor in retaining high-potential employees. Processes such as mentoring can also be vital to ensure the transfer of unique expertise from any personnel with retirement on the horizon.

Obtain a Company Valuation

Valuation experts can apply a variety of methods to assess what your business is worth. Your company’s size, industry and the circumstances under which it might be sold help determine the approach. This may range from an asset-based valuation based solely on the value of the company’s tangible and intangible assets, to an earnings-multiplier approach that reflects the firm’s earnings potential and a purchaser’s anticipated ROI. Positioning your company most advantageously warrants engaging the services of a specialist in the valuation process.

EP Wealth Financial Services

Obviously, there are many things to consider when preparing and implementing a succession plan, and the approach you ultimately take should reflect your own personal goals as a founder, as well as the specific nature of your business. As with taxes, technology, and legal contracts, seeking the assistance of a specialist can be a wise course of action. Please feel free to reach out to our team at EP Wealth Advisors with your questions about including small business financial planning guidance in your succession process, as well as taking advantage of financial planning’s capability to provide you a path to peace of mind.

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EP Wealth Advisors (“EPWA”) makes no representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information presented in this report. EPWA has used its best efforts to verify the data included in this report. The information presented was obtained from sources deemed to be reliable. However, EPWA cannot guarantee the accuracy or completeness of the information offered. All expressions of opinion are subject to change without notice.

Information presented is general in nature and should not be viewed as a comprehensive analysis of the topics discussed. It is intended to serve as a tool containing general information that should assist you in the development of subsequent discussions with the appropriate professionals. Content does not involve the rendering of personalized investment advice nor is it intended to supplement professional individualized advice. Always consult a tax and legal professional prior to implementing any of the strategies referenced here.

Hiring or working with an investment advisor or financial planner and/or establishing a financial plan do not guarantee investment success, and do not ensure that a client or prospective client will experience a higher level of performance or results. All investment and financial planning strategies are subject to profit or loss. The risk of investment loss can never be eliminated.

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