SUCCESSION PLANNING: Plotting the next step and beyond for your business


Preparing to exit is not easy, but thorough consideration is essential to protect value, continuity


July 06, 2014 4:30 AM
The Great Recession’s economic storm submerged many business owners’ plans to retire and sail off into the sunset. Thanks to a rebounding economy, those individuals and future retirees are encountering a brighter selling environment and are mobilizing plans to make their grand exit.

Unfortunately, most of those privately held business owners haven’t properly articulated their succession strategies.

“A lot of people put off business succession planning until the last minute,” said Bob Nemeth, principal of Independence-based Apple Growth Partners. “I’ve seen valuations really go down because a plan wasn’t in place. Ideally, they should start the process about five years before they retire.”

According to the Cleveland-based Exit Planning Institute, two-thirds of privately held businesses are not familiar with their exit options, and 83% have no written transition plan.

Perhaps those figures will ebb, as succession planners say they expect the current flurry of activity in business succession planning to continue amid the expected exodus of baby boomers leaving the work force or selling their companies.

According to the Pew Research Center, 10,000 baby boomers will reach age 65 each day for the next 19 years.

“What’s happening is that all these baby boomers owning businesses have to figure out what to do,” Nemeth said.

The current economy presents an ideal environment in which to transition leadership, as buyers flush with cash are courting businesses with rebounding valuations and healthy earnings, wealth planners say.

“Now that the economy has improved, the baby boomers are ready to sell,” Nemeth said.

First steps

Sellers typically opt for a family member succession, employee takeover or an outright sale to an investor.

Before outlining a strategy can even begin, the business owner needs to articulate his or her personal objectives and the goals of the business and then work with succession-focused professionals — such as attorneys, insurance agents and financial planners — to structure the plan.

“We help them spell out c-urrent facts, including cash flow, valuing business and where this succession strategy would put them financially now, five years down the road, or even 20 years down the road,” said Zachary Abrams, wealth management manager for Shaker Heights-based Capital Advisors.

Even though business owners may feel like a son or daughter is the logical beneficiary, wealth planners say that a proper evaluation may yield a different outcome.

“It can be uncomfortable, but an assessment of the business may reveal that a son or daughter is not the next logical leader,” said Abrams, who noted that lack of communication with children befalls many a business owner up until crunch time.

Ambiguity surrounding an owner’s next steps also has consequences for the leaders on deck.

“I’m working with a lot of next-generation business clients, and a lot of the challenges they are facing is that they’re not sure what their future role will be because mom and dad haven’t communicated with them,” Abrams said. “I had a friend who left his family business because he couldn’t get that conversation started, and the risk was too great surrounding his future.”

The price of selling
Once owners determine their succession strategy, they next should seek an independent valuation of their company.

About 56% of privately held business owners feel they have a good idea what their business is worth, yet only 18% have had a formal valuation in the last two years, according to the Exit Planning Institute, an international membership organization of exit planning professionals.

“The main purpose of succession planning is not just to give away the business, but to increase its value,” said Nemeth of Apple Growth Partners. “If you want to sell it in five years, you’ll want its value to rise.”

For some, cash from the sale of a business may be the departing owner’s main source of retirement income, or he or she may want to distribute the proceeds in a child’s trust account. For others, their primary motivation for maximizing the company’s value is to ensure its longevity.

“They put their heart, soul and sweat into the business, and want to see the next owner carry on that legacy,” said J.P. English, wealth planner and vice president of Cleveland-based Key Private Bank.

Don Kuehn, former owner of Broadview Heights-based Warwick Communications, recalls weighing the decision of accepting an outside investor’s offer versus the chance to sell his second-generation business to existing employees who didn’t have cash up front.

“The more I talked to the outside company, the more I realized I wanted my business to be run by my employees, who I knew would take care of my customers,” he said.

Kuehn’s decision has apparently paid off, as the 36-employee firm that provides communications services to businesses has increased sales about 24%, despite an ownership transition that occurred during the depths of the recession.

“We always say that writing a check for a company is one thing, but being responsible for 30-some families is another,” said Heidi Murphy, a principal and vice president of finance. “We’re really vested in this business.”

Other succession plan building blocks involve taxes, though owners shouldn’t allow those costs to steer their strategies, said Neil Waxman, managing director of Capital Advisors.

Virtually everyone is impacted by the income tax, although the amount varies greatly depending on whether the sale is structured as an asset sale (where the assets of the company are sold to the buyer) or a stock sale (where stock in the company is sold), said English, of Key Private Bank.

Asset sales typically produce much more ordinary income, while stock sales typically produce lower-taxed capital gains.

Some family succession plans opt for an installment sale to spread the sale proceeds over a number of years, and therefore reduce the tax burden.

“But you have to rely on that note being paid over time,” English said. “That usually means the seller stays in the business in some capacity to monitor the company’s performance and cash flow.”

Even if retirement is a distant target, succession specialists suggest that the operator have an outside advisory board, with a leader that could step in if necessary.

For added security, the business should have a buy-sell agreement, which dictates how ownership would be transferred. A life insurance policy benefitting a surviving business partner should have a value making it possible to buy out a co-owner, should an unexpected illness or death occur.

Otherwise, shares passed to family members who have voting privileges but aren’t a part of the business creates turmoil and risk.

These landmines can be avoided if a plan is in place, wealth planners emphasize.

“The two biggest mistakes a business owner makes in succession planning is moving too quickly and waiting too long,” Waxman said. “Succession planning is not a project, it’s a process.”