Planning for the Next Generation or Just a Day Off--Succession Strategy Benefits Business Owners

by Darla Dernovsek

Succession planning for small businesses is about much more than simply keeping the doors open. It's about achieving goals that may range from funding your retirement, to continuing a family operation into the next generation, to simply making sure your business can keep running when you take a day off.

While many business owners are interested in leaving a lasting legacy--for their heirs or for their employees--many still avoid addressing business succession issues, according to Sharon Danes, professor and family economist at the University of Minnesota, St. Paul, Minn., and Galen Loven, Valleyford, Wash., author of "Success(ion) Planning for Closely Held Businesses" and the business ethics site, Morals & Ethics, and a consultant who works with business owners on succession issues.

Danes has conducted numerous studies on succession issues for rural family businesses, available online. She also shares information about rural business issues by coordinating the Rural Minnesota Life Web site.

Creating gradual transitions

Danes says the majority of research on family businesses deals with succession issues, which reflects the difficulty of the task for both business owners and their advisers. Lack of time is part of the problem, along with avoidance of pondering unpleasant prospects such as aging, loss of health, and even death.

But the biggest barrier may be the tendency for owners to look at succession as a single event that occurs when the business changes hands due to death or retirement, rather than a gradual transition that prepares the next generation or the next owner to successfully take over.

That transition must create a plan to tackle four areas: marketing, finances, production, and daily operations. When the transition strategy is successful, it creates a bond of shared knowledge between the business owner and the successor, who may be either a family member, an employee, or an outside purchaser. A sound transition strategy also outlines the role participants in the transition will play, both now and in the future.

"Sometimes business owners want to keep their fingers in things for a long time, but with a shared transition plan, everyone knows their role in that transition," Danes notes.

When family members are taking over the business, Danes says there also can be ethical dilemmas linked to distributing assets fairly among children, including the share due to children who worked in the business compared with those who pursued other occupations. Determining which heir is best equipped to lead the business also may be difficult.

Waiting too long

As a consultant, Loven has watched as business owners let the profits from the work of a lifetime slip away by failing to address succession issues. Many business owners find it unbearable to think about life after the business is gone, so they pass on highly profitable opportunities to sell. The same issue can affect family-owned businesses, where the older generation may be unable to consider "giving up" their position in the family and the business.

"The business owners who do the worst succession planning are the ones who have no ability to see beyond what they're doing day to day, without taking time to look at the bigger picture," Loven says. "The people who do the best job of succession planning are the ones who have something else to do after succession or have something to look forward to."

Waiting too long also can make it difficult to pass vital business knowledge and contacts on to the next generation, which might include key employees, family members, or an outside buyer. Establishing successors as business authorities is essential for generating repeat business from existing customers, marketing to business prospects, and creating a trustworthy reputation with suppliers, credit unions, and other financial institutions. Failing to plan ahead also can eliminate opportunities to decrease the tax burden for both the owner and the heirs.

"One very good alternative succession strategy is to build your company not to succeed you in ownership, but to succeed you in day-to-day management," Loven says. That protects the company while the owner or heirs determine whether it should be sold to family members, employees, or an outside buyer.

Planning ahead

Lower fees--Danes notes that business owners who have thought through what they want to achieve from succession planning before they meet with consultants, attorneys, or accountants will have significantly lower fees. Although the experts will iron out the details, it's up to the business owner to determine succession objectives.

A brighter future--The business has a far greater chance of surviving if key employees or family members are capable of understanding business challenges, recognizing opportunities, interacting with customers, and conducting day-to-day operations. Examining succession issues may also prompt the business owner to hire the expertise needed to expand the business, perhaps by tackling new opportunities or by adopting new technology. Family businesses also must verify that the next generation truly wants to run the business.

Greater freedom--Small businesses are often highly specialized, which often makes the owner a vital source of expertise. As a result, owners work long hours and often stay in constant contact even when they have a day off. Training a successor to run the business can give the owner freedom to take vacations and holidays without worrying that the business will fall apart. It also can provide reassurance if the owner is disabled, because the business will be prepared to keep running until a buyer or successor is determined.

Better advice--Business owners who plan ahead can select the right advisers to help them. Credit unions that offer business services can direct business owners to succession planning resources. Experienced accountants and attorneys can be excellent sources of information, and the Small Business Administration also offers advice about succession planning.

More financial options--Unless the business has an outside buyer with plenty of cash, the succession strategy may depend on whether heirs, employees, or other buyers can obtain financing. Financing can be even more difficult in businesses where family members accepted lower salaries to help build the business, which may leave the family members with less capital to finance a purchase. Advance planning may make it possible to begin transferring shares of the business, obtain life or disability insurance on the owner or other key individuals, or use other tools to generate money to pay for the business transition. When the business is sold to an outside buyer, planning ahead can help reduce the tax burden and reinvest the proceeds wisely to finance retirement or other goals.

Tackling the elephant

While planning ahead for succession takes precious time, it's always worth doing. Loven compares tackling the task to answering the question, How do you eat an elephant? The answer is, one bite at a time.

"It's not as complicated as people make it out to be," Loven says, "but it does require looking at the business truthfully, honestly, and candidly, and saying, 'This is where I am now, this is where I want to go, and this is how I'll get there.' Just put that elephant on your desk and start taking little bites."

November 1, 2004