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March 2012
The Importance of a Sound Succession Strategy
By John W. Kapelar

     Entrepreneurs who operate their own business wear many hats. Chief executive officer, controller, chief operations officer, to name a few. The focus of their efforts is commonly on matters that affect today. How can we generate more revenue? How can we increase our profit margins? How can we handle our ever increasing working capital needs? These are the “fires” that are fought daily.

     While most business owners are very astute in handling the day-to-day matters, the future, and more importantly the future of the business without them, and what to do about it, is something that is commonly glossed over.

     A closely held business without a succession plan, coupled with inadequate or nonexistent estate planning, can result in excess estate taxes, family feuds and general chaos upon the retirement or death of a significant owner. This is why a succession strategy is such an important piece of the puzzle for the future success of the business.

 

Ask Yourself Some Questions.

Before getting started with the process of succession planning, it is worth the effort to ask yourself a few questions:

Ø   Is there someone available within your company to take your position? Do you feel confident in their ability? Be honest and objective when evaluating the strengths, weaknesses and capabilities of the people who will be running the business when you’ve stepped aside. If nobody currently exists who fits your profile, you may have to look to selling to an outside party.

Ø   Consider what will happen when you no longer receive compensation as an owner? Will you be financially secure without having to receive additional compensation after your ownership interest has been transferred? If additional compensation will be needed, make sure that it is discussed and agreed on how it will be achieved.

Ø   Have you prepared your key members of management for the transfer? Are they adept enough to handle the “known” and the “unknown” of what you do? If they include members of your family, do they have the capability and more importantly the desire to become the next face of the company?

Ø   What is the value of the company and what price are you willing to accept for your ownership interest? Often owners believe that the value of their company is one thing, while an independent party believes it to be another. Having a valuation of the business performed or a buy-sell agreement in place can assist in the process.

Ø   Where will the funding come from? Consider what the funding mechanism will be for the transfer. Will it be a seller-financed note, cash, the future earnings of the company, or a combination of all three?

 

     Once you have determined how you want to transition your business and have invested time and resources to draft documents for the process, you need to step back and ask the question: What could go wrong? The following are a few of the common pitfalls that can plague even the most adroitly drafted succession plans.

 

· Inadequate or nonexistent communication

If the company has a mission, then everyone has a role in its success. But members of the prior generation and members of the next generation often don’t discuss exactly what the plan is when the current ownership leaves. Who gets what, who owns how much, what will happen when the business owner leaves the company, or who will be responsible for what duties are some of the questions that need to be adequately covered.

 

· An over-promising and non delivering owner

The owner promises all things to the next generation but doesn’t put a plan in place to ensure promises are kept. This results in disappointment, anger and confusion when the owner retires or dies. This can commonly be an issue when the transfer of ownership is within a family.

 

· Lack of liquidity

Failure to plan ahead from a liquidity standpoint can reap havoc on the next generation’s ability to manage operations. Limited working capital can strain cash flow when the buyout of an owner is added to the company’s existing operating needs. Additionally, insufficient reserves may also cause those left behind to be faced with a massive estate tax bill and no way pay for it. Without sufficient liquidity to pay the estate tax bill, the company may be forced to sell the business at a bargain price.

 

· Delayed planning

There are numerous effective ways to help minimize tax and succession problems, but procrastination is not one of them. Planning early is essential.

 

     A successfully operated closely held corporation can often be the most valuable asset that you own. Some of these entrepreneurial ventures will grow to the point that they become publicly traded companies, making their founders millionaires.

     But what about those that are not that fortunate? What will happen to that valuable asset that you have nourished, and cultivated when you are no longer there to run it? Will it wither and die on the vine because there is no plan in place? Or will it continue to grow and provide fruit for yourself and future generations for years to come?

     A diligently planned out succession plan is vital to the continuity of any closely held business and the blueprint for not only your future, but that of the next generation of owners. If you are in need of a succession plan, talk to your accountant. With the knowledge that they already possess of your company, they can assist in developing a plan tailored to your needs.

CPA, CVA, Managing Director with Potter & Company, P.A.
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