succession planning

Kurt Kofford, a CPA and director at BiggsKofford CPA Firm, was shocked and disappointed recently when he visited a small business where he’d been a customer for years, and found it was closing.

There was some manual labor involved in the service the business provided, and the owners no longer wanted to do the physical work.

“Even though they had a profitable, successful business and a lot of potential demand going into the future, they hadn’t identified and implemented a succession plan,” Kofford said. That left them with no alternative but to shut down.

The business wasn’t a client of Kofford’s, but he has worked with several small businesses in the past couple of years to develop succession plans.

Kofford recommends that businesses start thinking about succession planning sooner rather than later.

“Sometimes it affects the way you set up the structure of the business early on,” he said. “Plus, every time I have gotten a client to focus on what it might look like when they want to sell their business, it motivated them to get ready to sell, which makes the business better.”

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The planning process

In the purest sense, succession planning means determining how assets and owners’ stock are going to transition to family members or other trusted employees or key people.

“It is important in order to allow the owners of the entity to provide the benefits that they desire for family members who may be involved in the business, as well as managers and employees, or other stakeholders,” said Brad Lam, senior attorney at the Business Law Group. That could include people who have loaned the company money.

“Another reason is because we want, generally, to give credence to the founders’ intentions upon their departure,” Lam said. “Succession planning is the vehicle through which to do that most effectively and efficiently.”

The succession planning process is “moderately complex,” Lam said. On average, it takes 60 to 90 days, but it can take longer if a number of family members and stakeholders are involved.

“There are a lot of goals that can be accomplished through a succession plan. You can address other family members’ needs and requirements, and you can address managers’ and employees’ goals and aspirations,” he said.

One of Lam’s clients, a small, closely held business with one founder, had two silent partner investors. The founder wanted to transfer his ownership to a younger family member but needed to get the silent partners to sign off on the plan.

“They had the ability, as current members of the entity, to influence or stop a lot of work he wanted to do,” Lam said. “So we had to do a lot of negotiating to try to get the transfer to occur exactly as he desired it.”

Once a plan is formulated, it may require amending the company’s bylaws to contain the new terms and provisions the founders want. Some of those changes might need to go into effect as soon as the plan is approved.

Not all owners will be passing a business on to someone else. Some will prefer to sell their business when they anticipate retiring. That still involves decisions that can be handled in a succession plan.

“You’ve got alternatives as to what that sale may look like,” Lam said. “Is all of the business going to be sold, or just a portion? Is it possible to spin off a division or some sort of asset group of a small company? Do you have debt that needs to be paid off? Is there a trust to be created to benefit surviving family members?”

Each succession plan will be individual and unique. Lam said his firm has created flow charts that help navigate the decisions that need to be made, depending on the path the owners choose for themselves.

Financial components

Tax planning is an important part of the process that relates to both the initial setup of the business and the structure of a future acquisition, Kofford said.

Without properly and creatively structured succession and tax plans, a succession can end up costing much more in taxes and a greater percentage of the proceeds of a sale may go to taxes.

“If you do one of those without the other, you’re not going to end up with the same level of success and rewards,” Kofford said.

“We just worked on a very successful family business transaction, which involved a combination of selling part of the business to them for fair market value and then gifting part of it because of the desire to make sure that they didn’t pay estate taxes,” he said.

After putting a succession plan in place, it’s important to monitor it annually, at least.

“An update where you take a real serious look at it should occur anytime there’s a major event, whether it’s a life event or somebody coming into the business or wanting to leave the business,” Kofford said.

Both an attorney and an accountant should be involved in formulating and reviewing a succession plan. Kofford said he often brings in an attorney to be part of a client’s succession planning team, and there may be others involved as well, such as insurance representatives.

“Our most successful succession planning is usually facilitated in a company by its financial model,” Kofford said. “The best thing we can do is to create a picture of what it’s going to look like in the future. That gives us a roadmap to do the succession planning and a way to determine a fair price for family members to receive. Even if succession is a ways off, it still helps them be more successful in managing and running the business.”

HR considerations

Succession planning allows companies to better manage their staffing, said Renee Smith, HR consultant at the Employers Council, which advises businesses on human resources and employment law.

One question that arises around succession planning is the extent to which employees should be involved in the process. Actively engaging employees around succession planning can aid transparency and highlight skills gaps within the company.

“Succession planning is kind of mapping out the competencies of your key positions,” Smith said. But it’s also an ideal time to map out the skills that are required for all positions.

“If we are actively participating in succession planning, we can anticipate where we might have gaps in skills or abilities,” Smith said. That can lead to identifying development opportunities for existing staff, or it may have implications for future hiring decisions.

“There are times that when you have those conversations, there may be people you identified that once you talk to them, they’re really not interested, or there’s some fears on their part,” said Marnel Mola, director of Employers Council’s southern regional office.

“It’s not necessarily promising them that this is going to be their role, but helping to build that bench strength and those competencies across several people who could potentially step in,” she said.

Other employees may be disappointed that they were not chosen as potential successors, and even those who are selected may be demotivated to work for their advancement.

Some of these impacts can be mitigated by being transparent about why succession planning is important for the organization, Smith said.

Also, talking through those concerns may point the way for employees to develop the skills they will need to step into a future role — for example, offering the opportunity to manage a project or work on budget development, Smith said.

“Learning is reinforced through experience,” she said. “There’s an organization in town that’s preparing for the CEO to exit. They had identified three individuals within the organization that have the capacity to step in. They rotated those three individuals into the CEO role for 18 months at a time, where they had the opportunity to go through an annual planning cycle and a budget cycle.”

Many small businesses are not as on top of succession planning as they should be, Smith said.

“There’s a lot of behind-the-scenes work that needs to be done in terms of job analysis as well as gap assessments,” she said. “A lot of organizations find that the activities of daily operations get in the way.”

But business leaders, like the general population, are growing older.

“We’re getting to the point where a lot of those higher level positions are going to be turning,” Smith said. “So I would hope that employers are starting to pay more attention to it.”