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Business owners can transfer ownership to family members, or potential business partners in the event of their death. Here are five ways you can pass your business on without capsizing everything that has taken so much time and effort building up before it’s too late.
The “business succession planning for sole proprietors” is a way to transfer ownership of your business. There are 5 ways to do this.
Business succession planning is making logistical and financial choices about who will take over your company in the event of your death, incapacity, or retirement. The first stage in writing a succession plan is to select the perfect successor to take over the firm, followed by determining the best selling arrangement. A buy-sell arrangement is generally used, which is backed by a life insurance policy or a loan.
There are five main methods for transferring ownership of a company:
- Selling your shares or ownership interests to a co-owner is known as co-ownership.
- Passing ownership interests to a family member is referred to as heir.
- Selling your company to a key employee is a good idea.
- Selling your company to an entrepreneur who is not affiliated with your company.
- You may sell your ownership interests back to the firm and then distribute them among the other owners in a business with multiple owners.
What is a Business Succession Plan and How Does It Work?
A company succession plan is a document that provides step-by-step instructions to help with a transition of ownership. If a purchase is involved, the selling price and conditions are spelled down in detail, easing the burden on the leaving owner’s family. The leaving owner, the firm, the workers, and the successor all benefit from a well-crafted succession plan.
The following items should be included in a small company succession plan:
- A succession timeline contains information on the circumstances under which a succession might occur, as well as precise dates.
- Your probable successors are as follows: A list of prospective successors, along with their qualities and ranking.
- Standard operating procedures (SOPS) are a set of papers, procedures, staff handbooks, and training paperwork that have been formalized.
- Your company’s valuation: Your company’s valuation should contain the technique by which it is evaluated and be updated on a regular basis.
- How will your succession be funded? Details about how the succession will be supported, such as life insurance, a seller’s note, or other choices.
Who Should Be in Charge of Creating a Business Succession Plan?
Succession plans are often linked with retirement, but they also play a vital purpose early in the life of a business: if anything unforeseen occurs to you or a co-owner, a succession plan may assist avoid difficulties, drama, and financial loss. The requirement for a well-written succession plan develops in tandem with the complexity of the firm and the number of individuals affected by the departure.
If any of the following apply to you, you should consider developing a succession plan:
- Processes are complicated: When you go, how will your staff and successors know how to run the company? How are you going to replicate your subject-matter knowledge?
- Don’t only rely on yourself: Who will take charge of leading personnel, managing human resources (HR) and payroll, and appointing a successor and leadership structure?
- Have continuing contracts and repeat customers: Where will your clients go once you go, and who will maintain ties and fulfill long-term obligations?
- Have a plan for a successor: How did you get to this conclusion, and are they aware of and eager to take over?
Many company owners disregard succession planning because they do not feel it is required or wait until they are ready to retire to do it. A succession plan may not be essential for small, uncomplicated enterprises. Consider what would happen to your company if you were unable to manage the day-to-day operations. Who would be the next in line? Is the company going to be profitable?
When Should a Small Business Succession Plan Be Created?
Every company requires a succession plan to guarantee that operations continue and customers are not inconvenienced. If you don’t already have a succession plan in place for your small firm, you should do so right now.
While you may not want to quit your company, it is possible that you will. The closer a company owner approaches to retirement age, the more critical it is to have a strategy in place. When a transfer of ownership is imminent, such as when a firm is being listed for sale, retiring, or transferring ownership, business owners should prepare a succession plan. This will guarantee that the company runs smoothly throughout the changeover.
There are five different types of succession plans.
There are various instances in which a company’s ownership might change. The sort of succession plan you establish may be determined by the circumstances. You may also want to include more than one prospective successor in your succession plan to account for the unforeseen, such as sickness, accident, or death.
The five most prevalent forms of small company succession plans are described in detail below.
1. Assigning a Co-Ownership to Your Business
You may be contemplating your co-owners as prospective successors if you created your company with a partner or partners. Many partnerships form a mutual agreement that, in the case of the unexpected death or incapacity of one of the partners, the other partners will agree to acquire the business interests of the deceased partner’s next of kin.
This sort of arrangement may assist relieve the stress of a sudden change for both the company and the family. A spouse may want to maintain their shares but lacks the time or knowledge to help it grow. A buy-sell agreement guarantees that they are fairly compensated while also allowing the surviving co-owners to keep control of the company.
Drawbacks that might occur
A buy-sell arrangement with a co-owner necessitates having a large amount of cash on hand. Your co-owner should theoretically be able to buy out your shares at any time. Many firms will use life insurance to support this plan. Term life insurance is affordable and may help cover a variety of expenses in the case of a business owner’s death. Permanent life insurance is a little more costly, but it comes with the extra advantage of a payment if you retire or become disabled.
If you decide to write a buy-sell agreement with your co-owner, be sure to include a life insurance policy in the contract. In addition, the corporation may obtain key person insurance, which pays out if a key employee dies or becomes handicapped. For precise advice on the sort of coverage you’ll need, we suggest contact with an expert.
2. Handing Over Your Company to an Heir
Choosing an heir as your successor is a frequent choice among company owners, particularly those who have children or family members who work for them. It is seen as an appealing choice for providing for your family by entrusting them with the reins of a profitable, fully running business. Transferring your business to a successor is fraught with difficulties.
The following are some procedures you may take to ensure a seamless transition of your company to an heir:
- Determine who will take over: This is a simple option if just one family member is interested in taking over, but it becomes more difficult when numerous family members are interested.
- Give specific instructions: Include instructions for who will inherit the estate and how other heirs will be reimbursed.
- Consider a buy-sell agreement: Many succession plans contain a buy-sell agreement, which permits non-active heirs to sell their shares to active heirs.
- Determine the future leadership structure: In organizations with many heirs, but only one who will take over, offering explicit instructions on how the structure should look going forward may help to ease future conversations.
If these procedures are not addressed, the transition may become chaotic. For example, if a future leadership structure is not developed and the firm is passed down to several heirs, the subsequent power struggle may have a detrimental influence on the company. Alternatively, either heir may make the mistake of assuming the other will take up day-to-day duties.
A future leader must be picked before instructions on who will take over control of the company may be issued. When more than one heir is interested in taking over, things are likely to become complex. To help choose a successor, company owners might look at present contributions and obligations from possible successors.
Drawbacks that might occur
Making business choices as a family may be difficult. Emotions may be volatile, particularly in the aftermath of a sudden loss or disability. Furthermore, second-generation enterprises seldom survive the changeover, since they are often sold or fail outright by the inheriting family member. Following an inheritance, only around 30% of businesses remain the same name and ownership.
Overall, this raises the issue of whether inheritance is really a good concept. If your replacement is capable and business-savvy, the answer may be “yes.” If not, you may want to explore selling your company to a co-owner, important employee, or an outside buyer.
3. Consider selling your company to a key employee.
A key employee may be the perfect successor if you don’t have a co-owner or family member to entrust with your firm. Consider hiring personnel that are seasoned, business-savvy, and well-liked by your coworkers to help with the transition. This is something that your org chart can assist you with. If preserving quality after your leave is a priority, a key employee is usually more dependable than an outside buyer.
A buy-sell agreement is required for a key staff succession plan, just as it is for selling to a co-owner. Your employee will agree to buy your company at a set retirement date or in the case of your death, incapacity, or other inability to operate the firm.
Drawbacks that might occur
Money is a frequent obstacle to crucial staff succession. The majority of workers are unable to purchase the company for which they work. Even if they are, having sufficient liquid cash on hand is a problem.
Seller financing is one option, in which your employee repays you (or your family) over time. A 10% or greater down payment is usually required, followed by monthly or quarterly payments with interest until the purchase is completed. The loan’s particular conditions will need to be negotiated and then explicitly written out in your succession plan.
4. Selling Your Company to a Third Party
When there isn’t a clear successor, business owners may turn to the community for help: Is there another entrepreneur, or perhaps a rival, who could be interested in buying your company? To guarantee that the firm is sold for the right price, make sure the business value is calculated correctly and updated on a regular basis.
Some sorts of enterprises will find this simpler than others. If you own a more turnkey business, such as a restaurant with an excellent general manager, your job is to simply show that it is a smart investment. They won’t have to get their hands filthy unless they want to, and they’ll have plenty of time to concentrate on their other businesses.
Meanwhile, if you own a real estate firm that is branded under your own name, it may be more difficult to sell. Buyers will perceive the necessity for rebranding and remarketing and may be unwilling to pay full price as a consequence.
Rather, you should plan ahead of time to sell your company; recruit and train a superb general manager, standardize your operational processes, and have all of your finances in order. To make your firm more appealing and desirable to outside purchasers, make it as solid and turnkey as feasible.
Drawbacks that might occur
The unexpected is one of the major disadvantages of an outside sale succession plan: It’s practically hard to know ahead of time what the sales process will entail. The process of selling a company to a third party is complicated, and you may run into issues such as your business not being as valuable as you expected, a lack of serious purchasers, or your firm not being able to sell at all. Business brokers, such as VNB Business Brokers, are knowledgeable and competent in all areas of selling and buying companies on behalf of their customers.
Consider hiring a business broker to sell your company so you can concentrate on operating it and keeping its worth while specialists handle the sale. VNB will take care of all aspects of the process, including identifying and screening purchasers, structuring your sale, drafting documentation, and negotiating terms, in addition to taking care of unforeseen complications. VNB Company Brokers can tell you what your firm is worth, whether the valuation price may be enhanced, and how long it will take to sell your business after only one phone conversation.
Schedule a free appointment now to learn what your next steps should be.
5. Returning Your Stock to the Company
Businesses with several owners may choose the fifth option. An “entity purchase plan,” sometimes known as a “stock redemption plan,” is a contract in which the company buys life insurance for each of the co-owners. When one of the owners dies, the firm uses the life insurance money to acquire the dead owner’s business stake from his or her estate, giving the remaining owners a bigger portion in the company.
Drawbacks that might occur
A cross-purchase, in which you sell your shares to a co-owner or co-owners, is comparable to an entity buy. In most cases, a cross-purchase is the most cost-effective option. When co-owners buy shares directly from the company, they obtain a “step-up in basis,” which means the stock’s basis is revalued at the current price. The original basis remains with an entity acquisition, and your co-owners may be responsible for possibly larger capital gains.
Despite this disadvantage, entity acquisitions might be advantageous when there are a high number of co-owners. It might be time-consuming to draft cross-purchase agreements with each owner. In contrast, an entity acquisition agreement is substantially easier to execute. Each co-owner may usually be covered by a single life insurance policy.
What is a Succession Plan and How Do I Make One?
There are numerous critical phases to building a complete small company succession plan, as well as different approaches to taking. Depending on the intricacy of the plan and the company, some business owners may want to construct their own succession plan, while others may prefer to hire a professional.
The five stages to establishing a succession plan are the same whether you do it yourself or hire a professional:
- Establishing a timeline: Determine when the succession should occur, whether on a set date or in the case of death or incapacity.
- Choosing your successor: If you’re not buying from a particular party, make a list of three or more prospective successors and fill out a profile for each.
- Putting your regular operating procedures in writing: Include an organizational chart, personnel handbook, operations manual, and any other regular meetings or processes in your standard operating procedures (SOPs).
- Putting a value on your company: There are many ways to put a value on your company. Once you’ve established the worth of your company, you should keep it updated on a regular basis.
- Putting money into your succession plan: Define a defined roadmap that outlines how the firm will be purchased by the successor. Life insurance, a loan, and seller finance are all options.
Providers of Small Business Succession Planning
Because putting up a small business succession plan may be difficult, many business owners use a professional third party to assist them in determining the worth of their company, determining the kind of succession plan, and creating any necessary documents. The intricacy of the company as well as the event being organized may influence the supplier selection.
Providers of Small Business Succession Planning
The intricacy of the company and the number of people involved will determine whether you hire a major accounting firm or a local certified public accountant (CPA) to help with succession planning. Small firms, even sole proprietorships, may benefit from the assistance of a small business mentor, which may be found via organizations such as the Service Corps of Retired Entrepreneurs (SCORE) and Small Business Development Centers (SBDCs).
A local CPA or a company attorney to assist you create the documentation may be a reasonable alternative for small firms with several workers and basic to sophisticated finances. A company attorney and CPA should likely be engaged in more complicated cases to guarantee that everything goes well when the succession plan comes in.
Finally, company owners with bigger, more sophisticated organizations may want to consider dealing with an accounting firm that has considerable expertise preparing business succession plans. Hundreds, if not thousands, of similar businesses exist. Entrepreneurs may begin by studying local companies or work with one of the so-called “Big Four” accounting firms, such as PriceWaterhouseCoopers (PwC), which specializes in privately owned enterprises.
Pro Advice on Succession Planning
1. Avoid typical blunders.
Asghar Kazim, CFP, ChFC, CLU, Principal & Co-founder, United Wealth Group LLC.
“Failure to examine one’s succession plan on a regular basis is one of the most prevalent blunders made by company owners.” Many things change over time, and your succession plan must be evaluated and modified on a regular basis to reflect any changes. These might include, among other things, corporate changes, tax legislation modifications, value adjustments, and new industry developments.
“Changes in family dynamics—do all members have the same desire for what to do in the future, or are all key players still with the business?” “For family-owned businesses, you’ll also need to consider aspects like changing family dynamics—do all members have the same desire for what to do in the future, or are all key players still with the business?” To reflect developments like this, company owners must update and adapt their business plans.”
2. Make your succession plan when the timing is appropriate.
Principal Attorney, Sorrell Law Firm, PLC Whitney L. Sorrell, JD, CPA, MBA
“Business owners should begin succession planning at least 5 years before they plan to retire. Many business owners want to pass their company on to their children or grandchildren in a way that minimizes tax liability, keeps business assets in asset-protected structures, keeps cash flowing to the business owner after succession, and ensures a smooth transition of management to the next generation.
“Over time, the strategies that deliver these advantages produce greater outcomes. Other business owners are looking to sell their company to a third party. Allowing time to prepare the company for sale will result in the highest potential price, and allowing time to correctly organize the sale will result in the least legal tax obligation and the best degree of asset protection when the selling price is received.
3. Think about the advantages of succession planning.
Alexander Abramson, PLLC was founded by Ed Alexander, Esq.
“One of the advantages of succession planning is that you don’t spend 30 years operating and creating a company just to walk away empty-handed.” It will be exceedingly unprofitable to liquidate and close up business rather than sell out. The bulk of a company’s worth lies in its goodwill and intangibles, not its physical assets.
“Failing to plan is intending to fail,” I warn my clients. Many times when I’ve visited with clients after their company sales, they’ve told me, “I wish I’d begun preparing sooner.” They’re pleased with the result, but it’s only afterward that they understand how much even six months of preparation might have enhanced the selling price.”
Conclusion
Although many experts advise starting succession planning three to five years before retirement, it is never too early to start. Knowing how your firm will transition, who will take over, and how heirs and partners will be reimbursed are all important factors in decreasing future stress in the case of an owner’s unexpected retirement.
Business succession planning is important to ensure that your business will be able to continue without you. Here are five ways to transfer ownership of your business. Reference: why is business succession planning important.
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