One area of concern that we frequently help our small business clients with is succession planning. It is never too soon to begin considering your exist strategies, as some aspects of a comprehensive succession plan can take years to develop. Here are some excerpts from a letter we recently sent to one of our successful small business owners who, though just 40 years old, is wisely considering his options regarding succession:
One of the elements in any complete business succession plan is personal estate planning. The two are so related that we really cannot address one without also thinking about the other. As a first step in the business succession plan, therefore, we need to make a start on your personal estate plan.
Life Insurance is another element in the succession plan that you should consider. This plays a role in a number of separate areas. First, adequate life insurance will provide short term liquidity to pay possible estate tax (state and federal) liabilities resulting from your passing. Second, it provides additional assets for your family – replacing income that may otherwise have come from your work. Third, the right type of policy (a key person policy) provides additional, immediate capital to your business in order to find and replace your role in the company. What constitutes the right amount of coverage is something you should research further (there are lots of opinions) and discuss with an insurance agent that you trust. Similarly, the type of policy or policies that you purchase (term, universal, whole life) is also the subject of lots of opinions and should be approached and answered as I have outlined here. Finally, do not forget to consider life insurance on your spouse as well – married couples with one employed spouse tend to under-insure the spouse who is not working outside of the home.
We also talked about your long-term goals for your current business. It was evident that, in the near future (5-10 years) you would like to see the business sold. This kind of a strategic goal needs a strategy in order to make your wish a reality, so we discussed several options, all of which focused on the potential buyer.
There are two basic categories of buyers to be thinking about with your business; an internal/succession buyer or an external/strategic buyer. Generally, an internal/succession buyer would be a family member or key employee (or group of employees). Obviously, the family member/purchaser is not an immediate likelihood now (this could change as the children grow, of course), and you have not yet identified any current employee having the interest or capacity to become a viable purchaser. I recommended that you take some time to reflect on what qualities, experience, characteristics, skills/training and aptitudes someone would need to have to be a viable, internal/succession buyer. This exercise will be helpful for you in hiring future employees – not so much for necessarily going out and looking to hire that person, but in recognizing such a possible buyer in someone who you were otherwise interviewing or hiring.
The external/strategic buyer will most likely be another company that does what you do, whether a local competitor or another company looking to expand into this market. It is possible that someone with no prior experience in your business could be a purchaser as well; this circumstance is pretty rare however, and I have only seen it occur once in my practice to date (that buyer had just sold another, unrelated business and was looking for a new investment – a new company to run. He sold it again within a couple years). There are a number of ways to go about exploring this avenue, including formally listing the business with a broker. Under your circumstances, the best approach will be discreet and direct discussions with other companies that you select and approach about a possible sale.
In that regard, you should bear in mind that you are negotiating from a position of strength right now, as the business is currently doing well and you have no immediate need to sell. Nevertheless, as I noted above, you do want discussions that develop beyond a preliminary stage to be discreet and should therefore be covered by a written non-disclosure agreement (“NDA”). This will help protect your business in at least three areas: (i) non-disclosure of your financials, (ii) erosion of customer base that can arise when word of a possible sale is leaked, and (iii) unease or flight of employees who believe their continued employment is at risk. I can provide you with a form of NDA to use if discussions progress as well as advice on when in that process the NDA is important.
Finally, the item that started this whole line of discussion was the phantom stock plan that I had put together for you last year. This project still has a role to play in your long-term strategy, even if that role is not immediately evident or necessary. The fundamental usefulness of a deferred compensation plan such as the phantom stock plan is that it builds loyalty by creating an incentive for key employees to stay with the company and to work hard to increase its value. So as key employees are hired or developed over time, the phantom stock plan is available as a means to retain those employees, whether or not they might also be or become internal/succession buyers.
