For most family business owners, transferring ownership of perhaps their biggest asset to the next generation — whether by sale, gift or bequest — is the largest transaction of their lives. Yet few have a formalized plan for making the transition.
Why you need a plan
Transition planning has always been important, but in today’s environment it’s particularly critical. At one time, retirement was a relatively brief phase of life, but today people are living longer than ever before. Maintaining your lifestyle in retirement while providing for your family demands a structured, formalized approach.
As the number of baby boomers looking to transition their businesses continues to grow, selling a business to a third party is becoming more competitive, while working through ownership changes with family members, management or employees is increasingly complex. To improve your chances of a successful outcome, you need to start planning now. Recent studies indicate that failure to conduct pre-sale planning is the number one reason deals fail. In fact, only one in five businesses are successfully sold. However, the number improves to nearly 80 percent for organizations that plan for their transition.
A formal plan helps take inventory of your current business and personal financial situation, determines where you need to be when you reach retirement age, and implements strategies needed to get there.
Three key objectives
There are many strategies, techniques and tools for business transition planning — but every transition plan is based on three key objectives:
1. Maximize business value
The first step is to determine the current value of the business.This includes analyzing the value drivers in order to identify opportunities to increase the business’s worth. For example, if your management team is weak or the business relies too heavily on you, training or recruiting management talent can increase the value of the business.
Of course, strategies for maximizing value depend on how the business will be transitioned and to whom. Preparing the business for sale to a strategic buyer, for example, will likely look very different from preparing for a sale to employees or gifting to family members. For more on business valuations, see Determining the real value of your business.
2. Ensure that you’re personally and financially prepared
How does the potential value of the business fit into your personal and financial goals for retirement? What will you need to support your desired lifestyle after you exit the business? What resources do you have outside the business? Will you need to continue working for a time after you exit the business? The answers to these questions determine whether the optimal exit involves a sale to a third party, a management buyout or a transfer to family members.
It’s also important to consider the timing of your exit. Will you work until the traditional retirement age or do you anticipate exiting the business earlier? Could health issues force an earlier exit? How might market conditions affect the value of your business at that time? What strategies to minimize, defer or eliminate capital gains, estate and income taxes will be considered?
If you plan to transfer the business to family members by gift or bequest, be sure to consider the gift, estate and income tax implications. There are a variety of techniques available to generate personal income while transferring the business in the most tax-efficient manner.
3. Plan for the “third act” of your life
Even if you’ve done all the right things to plan your exit, it’s just as important to have a plan for what comes next and to understand your expectations. According to a recent industry study, 75 percent of business owners who sold their businesses regretted the decision within 12 months.
Have a contingency plan
Ideally, you’ll transition the business in accordance with your plan. But what if death, disability, divorce or some other event forces an involuntary exit? To minimize risk to the business, it’s important to have contingency plans in place, including key person insurance, life insurance, buy-sell agreements, management succession plans and so on.
Consult professionals
Transition planning is a very complex process. Consulting experienced professionals is critical to maximize the chances of an optimal outcome, provide an objective perspective on your transition options and free up your time to work “in the business” rather than “on the business.”
