How to Keep Your Small Business Successful for Generations to Come
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John and Gail Kelley have owned and operated a Two Men and a Truck franchise in Columbus, Ohio, for the past 25 years, but they’re now ready to hand the reins to new owners and retire.
“It’s time to get out of the way and let somebody younger do this,” John Kelley said.
Since opening the franchise in 1993, John and Gail planned to eventually sell to an employee when the time was right. About three years ago, they got serious about their exit and started putting a succession plan into action. That puts the Kelleys in the minority — nearly 60% of more than 200 business owners surveyed by Wilmington Trust last year did not have a succession plan in place even though such a plan usually results in higher business values and a lower tax burden, to name two advantages.
John and Gail worked with their attorney to draw up a contract to sell the business to two of their managers, Stephanie and Justin Clarey. The Kelleys have reduced their involvement in the business during the past three years and will officially step away at the end of 2018.
While the Kelleys’ decision to leave the business was voluntary, many exits are unplanned, said Scott Snider, vice president of the Exit Planning Institute. Death, divorce and partner disputes are among the unexpected misfortunes that can shake up the leadership of a company, he said. Having a succession plan in place would ensure that your business could withstand unforeseen circumstances.
“By looking at the business with the end in mind, first and foremost, you will always be prepared for the unplanned,” Snider said.
What is succession planning?
As you grow your business, you may start to see signs that the company has staying power beyond one generation of ownership. If you want the business to continue operating far into the future, you’ll need to think about who is going to run it when you’re no longer at the helm. Your succession plan could include selling your company to new owners or keeping ownership in your family and bringing in new management.
Planning for the next generation of leadership is a standard process at large companies, but small-business owners may not prioritize a succession strategy, said Erik Kantz, a Chicago-based attorney at Saul Ewing Arnstein & Lehr. Kantz is also the Middle Market and Small Business Committee chair for the American Bar Association.
“In larger businesses, it’s baked into the cake, so to speak,” Kantz said. “In a family business, those things may or may not be in place.”
There are internal and external succession options for small-business owners, Snider said.
- If you want to pass down your company internally, you could sell it to employees through an employee stock ownership plan or a management buyout if you have key managers to take over the business. Selling the business to a family member would also be an internal option. The new owner would have to decide how to finance the purchase, perhaps buying out other family members’ shares in the process.
- An external succession plan could include selling the business to an outside buyer, such as a private equity firm or another company in your industry. You might also be able to give an outside party a share of the business without giving up management control.
Why should you make a plan and when?
It’s never too early to start planning for the future, Kantz said. If the business shows the ability to grow past one or two generations of ownership, you should start thinking about how to keep the doors open, Kantz said.
In family businesses, the first generation of owners may want other family members to continue operating the business, but the second generation may not have the same interest, Kantz said. This would create a crossroad for owners, as they would have to decide whether they want to sell the business or bring in outside management while keeping ownership in the family. It’s best to make sure all involved family members are on the same page and have the same goals, he said.
Business owners should set aside three to three-and-a-half years to carry out an exit plan from start to finish, Snider said. But many factors, such as how attractive the business is to buyers and how prepared the owner is to leave, could extend the process.
While you don’t have to hire an attorney to help you create a succession plan, there should be some formalities between you and the incoming owners, Kantz said. Any agreements, even between family members, should go beyond a simple handshake and include signed documents, he said.
The Kelleys and the Clareys worked with separate attorneys to draw up a contract that satisfied both parties in the transition of the Two Men and a Truck franchise. The contract went through four or five iterations, John said.
“Handshakes are not good enough,” John said.
What happens if you don’t make a plan?
Most business owners want to leave at some point, but they often don’t think about how they’re going to get there, said Daniel McKenzie, attorney and founder of Colorado-based The McKenzie Law Firm. New business owners may see succession planning and the associated attorney fees as an unnecessary expense, especially if they’re not sure about the business’ long-term future.
But the best time to start planning is during the business’ early days, McKenzie said. The longer you wait, the more likely it becomes for disagreements to rise between business partners or shareholders when someone decides to leave the business. One person may think they are entitled to a bigger share of the company than the others.
“If there’s not an agreement in place, it’s really hard for people to keep everything equal,” McKenzie said. “It’s very easy for that to get out of control quickly.”
You should also have a succession plan in place to protect your employees, Snider said. If you’re no longer able to operate the business, your employees would be at risk of losing their jobs and livelihoods. Any community organizations that rely on donations from your business would also be in a pinch if the company closes.
“We have an obligation to our employees,” Snider said. “It’s bigger than us, in a sense.”
Checklist for your succession plan
Review your business entity.
Your business entity affects the ownership structure of your company and what taxes you owe. Before the company changes hands, you could make sure the structure that you chose when starting the business still matches your goals for the company, as well as the new owner’s goals, Kantz said. The process to change your business entity could be simple or difficult, depending on which you first selected, he said.
Determine your valuation.
Before setting the price of your business, you need to know what it’s worth. You can find an accountant, an investment banker, a lawyer who specializes in business transition or a professional business appraiser to figure out your valuation. The method for determining your valuation would depend on the professional with which you’re working. John Kelley worked with a certified public accountant who relied on the franchise’s cash flow to determine its valuation, he said.
Set the rules for the sale.
A buy-sell agreement is a legal document that specifies who has the right to purchase the business and how the owner wants to sell it. Putting a buy-sell agreement in place is easier when you first get into business, especially if the company has multiple owners. It’s like a prenup for businesses, McKenzie said, stipulating who is entitled to what if things fall apart. The agreement would also detail what would happen to the business if an owner retires, goes bankrupt, becomes disabled or when he or she dies.
Communicate with the incoming owners.
All parties should communicate with each other about their needs and expectations throughout the transition, Kantz said. Everyone should be equally informed and should have an opportunity to voice concerns throughout the process. The Kelleys sat down with the Clareys many times throughout the transition of the Two Men and a Truck franchise. They would meet once a week to discuss the expectations on both ends and figure out a way for everyone’s needs to be met, Gail said.
Benefits of succession planning you can enjoy now
Peace of mind. The most basic benefit of succession planning is peace of mind for the owners, Kantz said. You can focus on other aspects of the business knowing that it will be in good hands if you decide to leave. The earlier you plan, the smoother the transition to new ownership will be, he said.
“If it’s early, you can work the kinks out of it,” Kantz said. “It’s also never too late to plan.”
You could also combine succession planning with your personal estate planning, Kantz said. That way, all your assets, including your business, would be taken care of if something happens to you.
Increased chances of financing approval. Having a succession plan in place would make you more attractive to lenders if you apply for business financing, Kantz said. If you’ve thought about the business’ future and have a plan for keeping it profitable, lenders might see you as less of a risk. You could be approved for better rates and terms if you have an exit strategy.
“This type of planning gives a lender comfort that you have more control of the business,” Kantz said.
Exiting on your own time. Since choosing the Clareys as their successors, the Kelleys have gradually reduced their workweek from five days to three to one day a week, Gail said. They’ve had time to adjust to life away from the business while helping the Clareys learn the ins and outs of running the company.
“We both feel like we’ve done as much as we possibly can to protect ourselves and provide the Clareys with as much opportunity as we had,” John said.