If you see retirement on the horizon, you may already be thinking about how to hand over the reins of your company. A well-designed succession plan allows your business to survive after you’re no longer involved with day-to-day operations. Creating a succession plan should be a top priority in your plans for the future, especially if your business is family-owned.
What Is a Succession Plan?
A succession plan is a written strategy that determines what happens to your business when you retire. Creating a succession plan can help protect the legacy of the business, provide continuity of service to the community, and provide financial security for both your family and the stakeholders in your company. You can develop and change your succession plan at any point, but you should begin creating your succession plan for your small business long before you plan to retire.
When to Start Planning
It’s never too early to start planning for retirement or to make contingency plans in case of death or disability. Preparing the business for transfer can take several years, so it’s best not to wait too long. While there’s no definite timetable that fits every business, experts recommend starting at least five years before the planned transfer. If you plan to retire sooner, it’s even more important to start your succession planning now.
Picking a Successor
One of the first steps in creating a succession plan is to decide how you want the business to run after you retire. Choosing a successor often depends on the current type of business you run. For example, in a partnership, your partners may simply buy your share of the company. If your small business is a sole proprietorship, you need to agree on a new owner beforehand. You also need to determine the transition period between you and the new owner. Once you establish this, you should draft the agreement with a legal representative to ensure that both parties agree. Even if the new owner is a family member, it’s important to complete the legal documentation to avoid future transition difficulties.
Family Member Successor
Often the solution to finding the right successor is choosing someone who’s already involved with your company. If you run a family-owned company, look at the other family members working in the business. You may need to train your successor in management skills before they’re ready to take the reins if they don’t currently have a leadership role. If you choose a family member who isn’t currently part of the business, it may be necessary to start this person off with an entry-level position and gradually increase responsibilities until you feel comfortable stepping away for extended periods. Plan ahead, increasing your potential successor’s responsibilities a little at a time, and step away from the company for increasing periods to see how they handle the responsibility.
Selling Within the Company
If you’re in a partnership, ask one or more of your partners if they have any interest in buying out your share of the company and taking control. This choice gives you assurance that your company can continue along the direction you’ve already set, and it minimizes disruption within the business during the changeover period. The new owner knows the company intimately and can take over right away, making this option appealing for co-owners who have to sell in a hurry or simply want to move on to other things. You need an agreement or buyout clause between the remaining shareholders. At this point, the company needs to have a valuation and each share price determined to help facilitate the agreement.
Some small business owners think of their companies as a ready-to-go retirement plan. Rather than planning for succession, they expect to sell their company and fund their retirement out of the proceeds. The fluctuations of the marketplace often derail this kind of plan, however, so the sale of your company should be only one element of your well-considered retirement portfolio. Selling to an outside investor transfers control and ownership of your company to any person or group that meets your price. The principal consideration in this kind of transfer is selling to the highest bidder, so the sale price may be higher with outside sales than with any other type of succession.
Even a sole proprietorship needs a solid plan of succession. Unless your business is a strictly one-person operation that can’t be done by anyone else, such as freelance writing or commercial design, it pays to consult with a few experts and formalize your plan well before you retire. Start with your accountant, who should know your assets and liabilities better than anyone. This professional can give you a clear picture of just what you’re passing along, as well as what it’s worth.
Talk to an estate planner if you’re looking to transfer your business after death, if only to spot the potential tax pitfalls your heirs have to navigate. If succession within the family has the potential to cause strife, consider investing in an impartial business consultant who can draft a report everyone agrees to abide by in advance. Outside advice can make the hard decisions much easier to formalize and reduce tension between family members during what promises to be a time of great upheaval.
Retirement Income Needs
You also need to determine how to address your income needs during retirement. If you plan to sell the business outright, the amount you receive must be enough to satisfy your retirement income needs over your lifetime. Taxes are also a crucial part of this sale; getting one lump-sum payment may create too high of a tax liability. Breaking down the payments over a few years helps reduce your overall tax burden. If you decide that a buyout is the best option, establish the payments with the eventual successor beforehand.
Another common option is to receive an annual income from the business in the form of a silent partnership or dividend. This establishes a stable and possibly growing income stream, depending on the success of the business. However, once you retire, you have none of the managing rights that a new owner enjoys. There’s also a risk that your income stream could diminish if the business fails in the future. Regardless of the successor, you should meet with a tax consultant who specializes in business succession planning to ensure that the transition is done in the most effective and tax-efficient way possible for all parties.
As you get ready to turn your company over to someone else, start earlier rather than later to make the transition as smooth as possible. Seek advice from your accountant, attorney, and estate planner to ensure a thriving future for both your business and yourself in retirement. You can also track your own financial situation as you plan to retire with QuickBooks. The QuickBooks Self-Employed app helps freelancers, contractors, and sole proprietors track manage your business on the go. Download the app and start planning your future.