Michael Lodge, NCPM, CRTP
WRITTEN BY: Robert Newcomer-Dyer - PUBLISHED OCTOBER 14, 2019: Writing a succession plan can be a daunting task. Indeed, many business owners put it off because they’re not ready to tackle the complexities. We’ve narrowed the process down to five simple steps to direct you along the way, including choosing your successor and determining whether to sell your business using life insurance, an acquisition loan, or other methods.
The five common steps to preparing a business succession plan template are:
1. Timeline of Succession
There are two key types of succession plans: an exit succession plan and a death-or-accident succession plan. You may wish to write a death-or-accident succession plan well in advance of when you think you’ll need it to protect your business and successors in the event of unanticipated events. An exit succession plan should be written when you have a specific plan to transfer ownership of your small business.
The two most common types of succession plans are:
- Exit succession plan: A plan to transfer ownership on a specific date, e.g., at retirement.
- Death-or-accident succession plan: A plan for one’s business in the event of their death or disability.
While an accident plan should be considered at any age, an exit succession plan should be written when you are within several years of retirement or wish to otherwise exit the business. When writing an exit succession plan, you should have a specific date that you would like to transfer the business, and indicate whether you will remain involved in the business post-succession or prefer a clean separation.
On the succession planning template, answer all the questions in section one. If you’re writing this succession plan to exit your business on a known date, fill out any remaining details, including how long you expect the transition to last.
2. Determining Your Successor
A highly important aspect of writing a succession plan is choosing who will take over the business. Many business owners plan to have a family member, such as a child, take over the business. Other common choices include a business partner or key employee in the business. And of course, an outside buyer is always a possibility.
Common successors business owners choose are:
- Family members
- Key employees
- Outside buyers
Choosing a successor may be difficult, and requires considering what is in everyone’s—including the business’—best interest. While keeping the business in the family may seem like a clear choice, keep in mind that second generation businesses have a high failure rate. For this reason, many business owners choose instead to sell the business and provide a cash inheritance for their family.
Consider filling out profiles for at least three potential candidates. This will give you a good preliminary comparison of everybody’s skill and experience. Even if you’re already set on a candidate, you may wish to have a backup plan in the event the person leaves your business or doesn’t want to become an owner.
3. Formalize Your Standard Operating Procedures (SOPs)
As a small business owner, you should understand the importance of recording and formalizing day-to-day functions. Standard operating procedures should be documented for your managers and employees to reference, as well as any future owners of the business. Important items to document may include a daily checklist of opening and closing procedures, training for new employees, and a performance management system.
SOPs vary from business to business, but often include the following items:
Common Standard Operating Procedures
Org Chart - A flowchart of your employee structure, including roles, departments, and who reports to whom
A rundown of daily functions—e.g., open & close checklist, a project management flowchart
An overview of any computer, tech, or software systems used by your business
A handbook that covers company policies, procedures, culture, benefits, safety, and more
A set of training and onboarding procedures, sometimes called talent management systems
Skill Retention Strategies
Plans for ongoing training—e.g., quarterly meetings, changes to employee handbook
An explanation of how employee performance is measured and reviewed
An overview of any other regularly held meetings, such as staff meetings and sales meetings
While not required, many businesses include standard operating procedures when writing their initial business plan, and update these regularly as procedures change and the business grows more complex. It is a good idea to have these SOPs in place prior to succession planning, as they will help your business grapple with growth and change.
4. Value Your Business
Figuring out the value of your business should happen early—and regularly. It’s an unfortunate fact that many business owners tend to overvalue their enterprise, and these misjudgments can snowball into financial errors when planning for retirement.
There are several ways you can determine the value of your business, from using a simple business valuation calculator to provide a rough estimate, to following more advanced methods for how to value a business, as well as hiring a professional appraiser.
A good practice is to consider the lowest price the business should sell for. When the business is eventually listed for sale, it may take a long time to find a buyer who is willing to pay your asking price. The succession plan should provide stipulations regarding how long to wait before dropping the price, how much to lower the price, and the lowest acceptable offer.
5. Fund Your Succession Plan
Few buyers out there have enough liquid cash to pay for your business upfront. This is why every succession plan needs a specific plan for how the buyer will make the purchase, whether it’s a loan, installment payments, or other option. The last thing you want is to reach your retirement date, or triggering event, and find that your chosen successor has no way to afford your business.
This is also why your funding plan will often need a buy-sell agreement. This is a legal document in which your buyer agrees to a specific course of action (like taking out a loan or life insurance policy) in order to afford the purchase. Once you’ve settled on a specific method of funding, make sure you meet with a legal professional to draft your buy-sell contract.
Common Succession Plan Funding Options
Life Insurance - Family member or partner takeovers
Acquisition Loan - Outside buyer or key employee takeovers
Seller Financing - Owners comfortable with taking payments over time
Here are the most common ways succession plans are funded:
Most commonly used when a family member or co-owner is taking over the business, a life insurance policy can help your successor purchase the business from you or your heirs. Contrary to how it sounds, life insurance isn’t only used in the event of one’s untimely death. Permanent life insurance builds cash value that can be taken out at any time, so it can also be used in the event of retirement, disability, or any other triggering event.
Life insurance arrangements are common in family successions, especially when you may have multiple children, but only one is taking over the business. With your chosen successor as the beneficiary, a life insurance payout can enable them to purchase shares from your other children, thus leaving everyone with some compensation and financial security.
An acquisition loan is money borrowed by the buyer in order to purchase the business. This is common when a key employee or outside party is taking over and they need some funding to afford the purchase. Buyers can typically get 70% to 80% of the purchase price financed from a bank or the Small Business Administration (SBA)—which is great news for sellers who want to be paid in full upfront.
Acquisition loans are secured against future profits of the business. While this makes them a generally reliable option, it also means a bit of work for the seller. Prior to the purchase, you’ll need to provide a lot of details about your business for the bank’s due diligence. Even then, however, the loan is not guaranteed. Pre-approval can provide some security, but it would need to be undergone regularly (every six to 12 months) up until the transfer date or triggering event.
Seller financing is when the buyer pays you back gradually over time. This is one of the easiest and most flexible arrangements, as the business owner and buyer can set whatever terms they like. Most agreements involve a down payment of 10% or higher, followed by monthly or quarterly payments with interest until the purchase is paid for in full. Again, however, the exact terms can vary widely.
The key downside to seller financing is the time it takes to get paid back. Especially if you’re relying on the sale to fund your retirement, a 20-year term may be less than ideal. However, given the flexibility of seller financing, it can be possible to find an arrangement that works for everyone.