If you’re a small business owner or family business owner, the statistics are stacked against you.
At least, when it comes to successfully transitioning your business rather than selling it for parts, you’re fighting against the odds. And make no mistake, you will collect a lot more value out of selling your business as an ongoing operation (a “going concern”) than you will out of selling its assets piece by piece.
According to Price Waterhouse Cooper, 77% of family owned businesses do not have a formal business succession plan. Similarly, Nationwide’s Small Business Survey shows that 60% of U.S. small businesses do not have a succession plan.
Historically speaking, when it comes to family businesses, only one-third will successfully transition to the second generation. Only 12% of family owned businesses will make it to the third generation, and less than 3% will make it to the fourth generation.
If family businesses were rare, these statistics may be no big deal. But according to the Conway Center for Family Business, 64% of all U.S. gross domestic product, 62% of all U.S. employment, and 78% of all U.S. new job creation, all are produced by family business operations. What’s more, 90% of all businesses in North America are family owned. Of those, 60% expect a change in leadership or ownership in the next 10 years as the Baby Boomers make their mass exodus from the workforce into retirement.
In other words, a big change is coming. And if we don’t plan for it, a lot of businesses won’t make it. A lot of jobs will be lost, and production will vanish.
So according to the numbers, if you fail to plan, you’re more than likely planning to fail. If you leave it to fate, then you’re playing Russian Roulette with your retirement, with your employees’ jobs, and with the community that relies on the products and services your business provides.
But these statistics have been around a while. Nothing I’ve said so far is ground breaking. So why do so few small businesses and family businesses have a formal succession plan? For some business owners, it’s because their standard of living is tied up in the business. In other words, the success of the business is directly dependent on the owner’s participation and management. The owner is indispensable such that if the owner left, the business would not survive. And neither the owner nor anyone else in the business would trust anyone else to pick up all the pieces.
For other business owners, it’s because running the business is tied to the owner’s psychological well-being, giving the owner self-worth, purpose, identity, and social interaction. Other owners are afraid to broach the subject of business transition due to uncertainty—fear of the unknown or of mortality. So they stay in the safe, sure place—relying on the day-to-day operations to fill their time. Some owners are afraid of making a hasty transition decision that cannot be undone.
Rather than trying to tackle an entire business succession strategy all at once, business owners can take a few steps to set themselves up for a successful business transition down the road. Below are a few first steps that all business owners should start taking immediately.
- Identify when you would like to make your exit from the business (i.e. retirement age). The answer to this may depend on your answers to Step 2. At the bare minimum, business owners should give themselves AT LEAST 5 years to plan for a successful transition of the business to a family member, key employee, or third party.
- Identify what you want from the business, what you need from the business, and what you want for the business. Most small business owners haven’t collected much value out of the business in the form of capital, retirement assets, or other investments. Rather, most of their time, money, and energy is tied up with the business. If you want to enjoy retirement for 10, 20, or 30 years, you will need to find a way to collect significant value out of the business before you leave or as part of the business transition. In other words, you’ll need to sell the business rather than give it away. Work with a financial advisor to determine how much you need from the business. Compare that to what you would like to collect in order to live the lifestyle you want. You’ll also want to consider what you want FOR the business. This may include ensuring that your employees keep their jobs through the transition, preserving company culture, or continuing community impact post transition. Identifying these priorities ahead of time will help to narrow down what approach you’ll take to transitioning your business, whether it be selling to a family member, to a key employee, or to a competing business.
- Identify possible successors and take steps to keep them around. If you have a child that has expressed interest in the business, begin grooming the child to do what you do. If it’s a key employee that shows initiative and leadership ability, get a Golden Handcuffs life insurance policy in place on that employee so that he has incentive to stay with you. Start the conversation with that employee about business ownership. The last thing you want is to lose that key employee to a competitor because the employee never knew of the prospect of upward mobility, or never believed you would follow through on the discussion.
- Make yourself replaceable. If you are indispensable to your business, you’re in trouble. To collect the value you need out of your business, you’ll need to show a successor or potential third party buyer (like a competitor) that the business can be profitable and manageable after you’re gone. If it’s a competitor, they’ll want to hire a manager to run it. If it’s a family member or key employee, they’ll need to understand everything that you do and be able to do it themselves. But if you never make it clear what all you do for the business, or if you don’t simplify your role such that someone else could step in and fill your shoes, then the eventual succession plan will likely fall apart. Start by identifying responsibilities you’re undertaking that could be delegated to an employee. Then lay out your job duties and processes so that they can be copied by your successor.
These are just a few starting points. Once you’ve begun, you’ll be in a much better position to pinpoint legal strategies for making a successful transition and timelines for transferring control to the successor. To view a 1 hour webinar on succession strategies for small business owners, click this link: https://youtu.be/G46YKUTLHbw.
For help structuring the transition of your business, contact a transactional attorney or one of Goosmann Law Firm’s Trust Law Counsel attorneys.