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By Dianne Killian, CPA, Tax Director for Arthur Bell

The demand for a succession plan is prevalent today as firms compete for investors and top talent who want to know there is a plan for business continuity should something happen to the principals. Common questions are who will take care of the business or what is the exit strategy? Firms that know the answers to these questions are proactive and have a competitive advantage.

Essentially, a succession plan is a will for your business. It dictates who will take care of the firm after you leave. Without it, the future of your business could be viewed as uncertain, and uncertainty is frowned upon, especially when it can be avoided.

A life changing or business event is often the catalyst to trigger succession planning. Yet when principals start their business, they should think about how the firm and investor assets will be managed if there is a change in status for a founding principal.

By creating a succession plan, you benefit from a level of institutionalization for certain aspects of the business so it can carry on without you being there. However, the planning process takes time. If you wait until an investor asks about your succession strategy, you might miss out on an opportunity.

Six steps to succession planning:

Since each firm is unique, each plan should be specifically designed to meet the needs of the principals, investors, employees, and business. To keep it simple, we discuss succession planning as a six-step process:

• Awareness of the need: It’s easy to ignore what we don’t want to confront today. By acknowledging the need for a plan to continue the business beyond your own involvement, you are taking an important psychological first step. Remember, just because this is a plan for the future doesn’t mean your business has to change tomorrow.

• Education of options: In the most basic terms, you have three main options to consider:

  i. Identify and mentor the next layer of deal makers who will take over the business;

  ii. Sell to another firm with a similar philosophy and strategy that will consolidate the business; or

  iii. Find a liquidator to distribute the stock to investors. Then the investors can choose the timing of when to trigger the gain.

  Although these options may seem simple, there are nuances that require the attention of your advisors (attorneys, accountants, and business consultants) to understand the ramifications to your estate, tax, and business plans.

• Decision-making: In this phase, we recommend that you thoroughly discuss the options with your trusted advisors, including colleagues, family, and peers, to determine the best scenarios for all parties involved.

  Some questions to ask yourself are:

  • Do you want your successors to buy into the business so they have skin in the game?

  • How much is the next generation of owners’ sweat equity worth?

  Your business advisors can help you run financial models for each option that you’re considering. The models could determine which option achieves your personal and business objectives in the most tax efficient way, and they could help you understand what your business is actually worth.

• Negotiation: After reviewing the models, you are ready to discuss and negotiate terms. If transitioning the business to the next generation of principals, the terms should incentivize and retain those principals.

• Drafting of documents: Once you agree to the terms, ask your attorney to draft the documents for your plan. Your major investors, accountants, and other business advisors should also be comfortable with the plan before moving forward. Sometimes there is a discrepancy between what the manager communicates and what the documents state in writing, so all parties should read the documents in detail to confirm the language represents the plan accurately.

• Implementation: It’s time to sign the documents and execute the plan. We sometimes see people who develop a plan but then stall at the implementation phase. Managers should know they can implement parts of the plan in phases to make it easier over time.

There are many benefits to succession planning: investor confidence, recruiting and retaining key employees, protecting the business, and peace of mind are just a few. At the same time, there are a few challenges that can prevent a succession plan from moving forward. Costs, time, and resources are some of those challenges, but usually the major hindrance to moving forward with a plan is psychological acceptance. The business is part of a legacy, and it can be difficult to come to terms with eventually letting go.

At the same time, you want to ensure continuity of your business. A succession plan ensures that you’ve taken care of your investors, your business, your employees, and yourself for the future.