You’re proud of the business you’ve built over the years. But at some point, you’ll be ready for your next adventure. And your business can be ready, too, if you start early. Here are five tips to help you get started on a business succession plan.
5 Tips to Get Started With Business Succession Planning
Missed opportunities abound when business owners don’t properly plan for a smooth exit. This is by no means a comprehensive list, but these are five things we think are really important to consider when creating a business succession plan:
- Set a target timeline.
- Assemble a team of advisors.
- Identify potential buyers early.
- Value your business.
- Decide between an asset or stock sale.
Continue reading below where we’ll dive a little deeper into each one.
1. Set a target timeline
Ask yourself when you ideally want to transition your business into new hands and work backward from there. Be sure to build in enough time not only to find a suitable successor but also, if needed, to mentor them in the business. You’ll want enough time to do everything you can to ensure a smooth transition.
2. Assemble a team of advisors
Once you know you’re ready to take the first steps in succession planning, build a trusted team that can help you at every step. Include your accountant and financial advisor, as well as a good business attorney. Your accountant will know strategies for reducing unnecessary taxes. Your financial advisor can help you maximize your retirement plan contributions in the last few years of eligibility.
3. Identify potential buyers early
An in-house successor is often a good option. Because they work with you already, they know your business and can put your client base at ease.
One or more of your family members may be interested to step in and take over. If more than one family member is interested, then seek their input to determine who will be involved in day-to-day operations, who will function as owners, and the compensation model for each. If you have other family heirs who will not be part of your business succession plan, this may be a good time to also consider how you’ll share other estate assets with them.
If you’re part of a franchise community, then it’s likely a free option for you to post your business in a published list of franchises for sale and seek buyers that way. Read our article, “How to Buy/Sell a Business With $0 Down” here.
4. Value your business
Your assets (like equipment or real estate), your client list and relationships, and even goodwill built up towards your business over the years are all valuable.
Bottom line, any business is worth some multiple of its cash flow – that’s the owner’s rate of return. A typical small business will sell for 4-5 times its free cash flow. Some types of businesses have special valuation metrics. For example, tax and accounting businesses often sell for a multiple of their gross revenue (usually 1x gross).
Do some homework to learn from other recent sales similar to yours. Look into franchise publications or other publications that list businesses for sale and look for related metrics that might apply to your situation. Contact the owners to learn from their experiences.
While a full-fledged valuation appraisal is an option, especially for specialized businesses (think funeral parlors, for example), I prefer reaching out to people in your industry.
Remember, whatever the value, your buyer will need to consider what it would cost them to run the business. They may have different financial obligations than you, and their cost of running the business may compute differently than yours.
5. Decide between an asset or stock sale
If your business is a corporation with stock, you and your buyer will need to make this decision.
Your buyer will likely want to buy the assets instead of buying your stock. That’s because they can take advantage of asset depreciation immediately and perhaps even avoid certain taxes for a few years until they pay off the business.
This could create a tax trap for the seller, though. If I am selling personal property such as equipment and it is depreciated out, it’s possible I would have to pay tax on the entire value of the equipment in Year 1. Even if it’s an installment sale or contract-for-deed carried out over a number of years. This can be avoided by properly structuring a lease.
Closing thoughts…
As I said, this is definitely not an all-inclusive list. It’s just something to get you started thinking. There are so many small details to consider when it comes to business succession.
For instance, did you know the buyer and the seller should file form 8594 — an asset allocation statement — and include it with their tax return in the year of transfer? This shows the assets included in the purchase and the price for both parties.
Little details like this one are why it is such a good idea to work with an experienced advisor to develop a smooth business succession plan.
At CSH Investment Management, we have nearly 30 years of experience in business succession — both as a buyer and a seller! Give us a call at 217-824-4211 and let us help you navigate these important next steps for your business.