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Succession planning

Passing down your business to a new generation or a business partner? Start preparing for the future of your company with our practical guide to business succession planning.

Guide

15 min read

1. Overview

Succession planning is used to identify and develop leaders who can transition ownership and management of a business to either the next generation or an employee.

Although complex, a well-planned succession plan can ensure the smooth and continued operation of a business.

  • Have the conversation about succession planning as early as practicable
  • Have a robust valuation completed
  • Set expectations to those around who may have an interest in being part of that next step
  • Involve professional (legal and accounting) expertise early in the process

Transitions that include selling a business, closing a business, and retiring are all part of the life cycle of a business, and you should prepare for them.

Succession planning does not need to be about passing from mother or father to child, it could be passing to an employee, or to an external person who wishes to take on and continue the business.

Family businesses have always been able to change and adapt to the marketplace around them, and therefore having a structured plan in place to move the business forward is essential.

In succession planning, the immediate thought is about passing the business down through a family line. However, the decision around who takes on the responsibility may be more down to those who work in the business and have the vision and passion to continue what has already been started.

No succession plan is the same as another. Each have their own individual complexities, meaning that the transition will be complicated. The main thing is always that all parties’ points of view are considered.

2. Business exit planning

Business exit planning is the process of explicitly defining exit-related objectives for the owner(s) of a business, followed by the design of a comprehensive strategy and road map that consider all personal, business, financial, legal, and taxation aspects of achieving those objectives, usually in the context of planning the leadership succession and continuity of a business. Objectives may include maximising (or setting a goal for) proceeds, minimising risk, closing a transaction quickly, or selecting an investor who will ensure that the business prospers. The strategy should also consider contingencies such as illness or death.

All personal, financial, and business aspects should be taken into consideration. This is also a good time to plan an efficient transfer from the point of view of applicable estate taxes, capital gains taxes, or other taxes.

The sale of a business is not the only form of exit. Forms of exit may also include initial public offering, management buyout, passing on the firm to next-of-kin, or even bankruptcy. Bringing on board financial strategic or financial partners may also be considered a form of exit, to the extent that it may help ensure the succession and survival of the business.

Small businesses, and especially family businesses, benefit from creating a disciplined succession process.

With the global proliferation of SMEs, issues of business succession and continuity have become increasingly common. When the owner of a business becomes incapacitated or passes away, it is often necessary to shut down an otherwise healthy business. Proper planning helps avoid many of the problems associated with succession and transfer of ownership.

Small business life is busy, so thinking about the future may not seem like a priority. However, whether you are planning to transfer business ownership to a family member or hand over control to your business partner or employees, planning ensures you can protect the challenging work after you have left the company.

Your role as business owner leaves a crucial gap to fill. If the unexpected happens or you simply decide it is time to step back, knowing your business will be in the right hands is reassuring.

3. Family Businesses

Family businesses are different from other types of businesses. This is because on top of business management and operations, family and ownership dynamics come into play.

To better understand this concept and its importance, it is useful to look at family businesses through a simple model.

THREE-CIRCLE MODEL OF THE FAMILY BUSINESS SYSTEM
Three-Circle Model of the Family Business System

Family, business, and ownership roles often overlap. Roles and relationships are complex, and crucially this system shapes the way a family business works.

Start planning early

It is never too early to plan for succession.

You might be thinking – ‘my children are too young,’ or ‘I’d rather focus on growing the business first.’ But the earlier you start thinking about the future of your business, the easier it becomes to make the right decision when it becomes time critical. More importantly, you will not have to make any difficult decisions as structures are already in place, and roles already agreed.

If you are a first-generation family business, think about whether you would like the company to stay within the family.

Research shows that the first transition is the most challenging one, as the firm moves from a centralised to a shared form of control. In this case, you should be considering questions like:

• How do I nurture the next generation to create the responsible owners of tomorrow?

• What kind of skills will the next generation need to succeed as responsible owners if they work in the family firm? What structures should I put in place to achieve this?

• How will the business attract the best talent going forward? Will this be family or non-family?

• If or when non-family come into the business, how do I make sure their ethos is aligned to that of the family firm?

All transitions involve change and uncertainty, not only first-generation ones.

In a multi-generational business, where both family and firm keep getting bigger, there are some additional questions to think about, including:

• Do we have the right governance structures in place to keep the family’s purpose aligned with that of the business? If not, what needs to be done about it?

• What kind of structures, if any, does the family business need when it comes to ownership and management transitions?

• Will all the next generation own shares equally? Can they all join the business in some capacity, or do they need to develop certain skills first?

When succession occurs within a company's hierarchy, succession plans should consider issues that may arise relating to retention of the intended successor, the possibility of jealousy by other employees, and how other employees will respond when they learn of the succession plan. Additional issues are likely to arise if succession is to a family member, particularly if more than one child of the managing owner works for the business, or if siblings who do not work for the business will gain shares without having invested time and energy in the business.


4. What are the benefits of succession planning?

  • Getting ready for the unexpected
  • Being clear on your retirement plans
  • Making the process easier
  • Having confidence your business will be in the right hands
  • Future growth of your company.

Transferring ownership does not happen overnight, but sudden change can. Being proactive will allow you to successfully implement a plan at short notice if you need to step down from the business, giving you peace of mind.

For example, if you are a limited company and want to share the ownership between several individuals, putting a shareholder’s agreement in place in advance makes the decision clear and avoids any arguments down the line.

Within the context of succession planning, where a small business is owned by a group of managers or partners, thought should be given to the transition of the business to the partners, how departure from a business will be managed, and how shares or ownership interest will be valued for purposes of sale or buy-out.

5. Why sell?

While many businesses run for years, even over several generations, businesses open and close all the time. Here are a few reasons why you may want to sell or close your business.

Business or professional reasons include:

  • Job offers from another company
  • A purchase offer for your business or your business assets
  • Dissatisfaction with sales and profits
  • Changes in the market or industry

Personal reasons to sell a business include:

  • Retirement
  • Burnout with self-employment
  • Health concerns or family needs
  • A desire to go in a new direction

6. Determine whether your business is saleable

Before starting your succession planning, you need to determine whether you have a saleable business. Here are some points to consider when determining if you have a saleable business.

  • Does your business have a history of strong profits?
  • A financially strong business has a lot to offer a new owner. If your business is struggling financially, the business will not be as attractive to buyers.
  • Sometimes a business does not even have a market value beyond the assets of the business
  • Is the business in an attractive industry?
  • Some types of businesses have more appeal than others.
  • Is the business in a location convenient to potential buyers?
  • Location is important to many businesses. Some businesses can be easily moved, others cannot.
  • Are your assets in good shape?
  • Having assets in good condition, with significant market value and remaining useful life, adds to the value of your business
  • Do you have quality inventory and good supplier relationships?
  • A prospective buyer wants to see quality (e.g., fresh) inventory and solid relationships with suppliers.

7. Determine your price

The value of your business can be determined by many business valuation methods. Most valuations are a combination of two factors:

  • Assets, such as cash, receivables, inventory, equipment, and real estate
  • Revenue stream, i.e, net profit over time.

Assets are usually priced using market valuation. Valuing revenue streams is more complicated, involving return on investment, comparisons to alternative investments, and growth potential.

Many owners get help from accountants, attorneys, and industry specialists when determining the value of their businesses.

8. Issues to consider in succession planning

Changing ownership can drastically shift how a business works, especially if it was set up by a group of people with different skills and experience. This is why choosing the right successor is so important. Working out how the gap left by someone leaving can be filled is crucial to ensuring that business is able to continue to perform.

Find a Successor

If you are passing the business to a family member, you may consider transferring ownership through your estate planning process. Often, however, new management comes from your pool of existing employees. If you have a larger business, succession planning involves preparing people for management and leadership roles to replace you or other managers when the time arises.

Finding your replacement can be difficult, so it is best to start early.

Leaders are not always easy to find, and it takes time to mentor someone into a management role. You will need to identify potential successors in your family or among employees. You can hire from outside the company, but it is helpful to groom someone already in your business, over a period, so the transition to new leadership will be smooth.

Train a Successor

Once you have successors identified, deliberately create a training plan to ensure that everyone involved has time to learn the skills, gather the information, and practice the leadership roles critical to the future success of the business.

Whether you are transferring a business to a family member or promoting employees into leadership roles, you need to plan. A succession plan takes into consideration the development of future leaders’ skills and abilities. The plan should deliver a return on your business’ training investment by providing for your successors’ advancement while simultaneously ensuring your successors do not leave your business. Even if someone does leave, a current employee should be ready to step into the vacated role. As the need arises, with good succession planning, employees or family members are ready for new leadership roles.

Ease Tax Exposure

Tax exposure arises when one generation gives way to the next generation in a closely held family business. In this case, succession planning, and estate planning become intertwined by the family.

9. When considering who to select - ask yourself

  • Do they have the right skills, training, and necessary qualifications? This may be more important if you are in a specialised industry.
  • Do they have relevant experience and knowledge about the business?
  • Are they interested in the business and its success?
  • Do they align with the values, mission, and goals of your company?
  • Do they have existing relationships with key stakeholders or long-term clients?
  • Will you still be retained in some capacity, for example as a consultant, and will this be properly documented?

If your business partner will be taking control of more of the business, for example, you need to assess how responsibilities will change. Can they manage additional responsibilities, or do you need to take on new staff to help you manage?

Leaving the business may mean you can no longer offer a particular service or skill as effectively. This might influence the way you grow your business in future. Do you hire people to maintain that same level of service, or do you gradually phase it out in favour of building up the remaining areas of the business?

Certainly, if you are selling your business, it is advisable to appoint a solicitor who can manage the complexities of this. As an example, an external buyer may want restrictive covenants, meaning that you cannot operate in competition to the business you have sold for a certain period and/or in a certain area. Likewise, upon exiting, it would be wise to seek certain indemnities from your buyer against any future legal action.

10. Make your plan for changing ownership of your business

Having your approach in writing gives you the best chance of a smooth transition with minimal disruptions. You should consider the following factors:

  • The potential timeline for transferring ownership
  • The person who will take over
  • Your business valuation
  • Key documents regarding employees, procedures etc.
  • Informing your staff

If your business changes ownership, the first thing you should do is notify your staff and shareholders. You need to let them know of the change to the management and running of your company and keep them informed of any changes that directly impact them. For shareholders, this is likely to be informing them of how their continued investment will work. The Transfer of Undertakings (Protection of Employment) Regulations 2006, (commonly known as TUPE) protect an employee’s rights when the business they work for changes ownership. Where TUPE applies, your employees will automatically become the employees of the incoming employer on their existing terms and conditions of employment, unless a redundancy situation applies. Employees are entitled to transfer on their same terms and conditions of employment, unless a redundancy-type situation applies, or there is a change to these for a reason not connected to the transfer.

There is also certain information about the transfer you are required to give your employees and employee representatives by law, as well as employee consultation requirements where the transfer may mean a change to their employment. You will also need to give the new employer certain information about your employees.

Staff also need to be informed if the transition of ownership may result in redundancies. If so, a fair redundancy consultation process should be followed with those at risk of redundancy. The correct contractual notice of a redundancy dismissal will need to be given and redundancy payments made to eligible employees following consultation where redundancies are confirmed.

11. Informing HMRC

Selling a business may change the way in which you are taxed. For example, you might run a business as an entrepreneur and be classed as self-employed, meaning you might fill in a self-assessment form.

If you sell the business but then stay on in a senior or executive role, you may find you are now classed as an employee and your taxation falls under an automated system, which changes the way you pay your taxes. If you own multiple businesses, it is worth talking to an accountant to assess the steps you need to take to ensure you stay on the right side of the law.

If you are selling a business to someone else with a plan to retire, you need to inform HMRC to inform them you have retired and that tax responsibilities for the business have passed onto someone else. If you are VAT registered, you may be able to transfer VAT registry to the new business owner.

12. Death

Obviously, this is not a pleasant subject to consider, but clearly one scenario where the spotlight will shine on what succession planning, if any, you have done, is when you pass away. Of course, this can happen suddenly and unexpectedly. If nothing else, it is always advisable to have a properly drafted Will so that your wishes are followed on your death. Without this certain intestacy rules automatically apply.

13. Help and advice for succession

There are several organisations that provide help and support for employee buyouts:

Your local Business Gateway can also provide advice and put you in touch with local support services.

In addition, both the business owner and employees will need professional advisers such as lawyers and accountants to help negotiate the buyout. If an employee Trust is being set up, the trustees also need advice. If you can, it makes sense to get advice from specialists with prior experience of employee buyouts.

Read guidance on how to choose and collaborate with an accountant.

Owner, employees, and trustees all need independent advice as their interests are not necessarily the same.

Get the support you need right now

You can connect with us through the contact form, call us or contact your local Business Gateway office.

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