The idea of succession planning is not a new one. World history, from China to Great Britain, is littered with tales of imperial succession. Whether these stories are triumphant or tragic, they all have one thing in common – the transition of power to the next generation. Some of the lessons learned in those stories are the same lessons we need to apply when succession planning in our businesses.
Plan your succession
This one sounds obvious when reading an article on succession planning, but the 2014 Report on Senior Executive Succession Planning and Talent Development, which is produced by some of Stanford University’s brightest business minds, recently published some key findings. One thing they discovered was that companies do not have a plan in place that will help them with each of the critical steps in succession planning. The report also reveals that succession plans should focus on maximizing growth and stakeholder value as opposed to minimizing succession risk. While the report focuses on large businesses, the underlying principles are sound without regard to the size of the business. While the vast majority of small business owners understand the importance of succession planning, a 2014 U.S. Trust report states that 66% of business owners do not have a plan in place. It is critical that companies of all sizes consider the need for succession planning, and have specific processes in place to accomplish the long-range goals of current and future stakeholders. The report recommends developing a plan that does the following:
- Creates a detailed job skills listing, and benchmarks the potential candidates against these skills
- Considers internal and external candidates
- Is comprehensive and ongoing in nature
- Assigns process ownership and the roles of the succession committee members
- Links training and development plans to current and future executives
- Establishes a network of coaches and mentors
- Enlists the help of strategic advisors
The goals of any implemented succession plan should accomplish these three critical tasks:
Identify your successors
Have leaders at your business determined who has the aptitude and acumen to lead your company into the next generation? In large companies, the leadership team that is tasked with selecting succession candidates can represent several groups – board of directors, current management, and trusted support staff may all be included. In smaller companies however, the selection process is often completed by current owners. Although small business owners play a wide variety of roles to make the business run, they are not frequently thinking about succession planning – at least not very far in advance. No matter the circumstances, it is imperative that the processes needed to identify a successor are put in place early enough to avoid some of the succession planning traps.
Train the talent of the next generation
One of the overlooked pieces of the succession planning puzzle is the need to provide the training necessary to equip the chosen successor with the skills required for his or her new role. Data from the report suggests that coaching and training programs are not sufficiently linked to succession planning objectives. This step can be especially critical when talking about small businesses where family lineage plays a more important role in successor identification. Even when successors have spent a lifetime working in the operations or finance division of a company, they are often overwhelmed by the breadth of skills needed when they assume the business’s leadership. Small business owners who are active in succession planning often are looking for a younger embodiment of current leadership. However, this approach does not adequately anticipate the future needs of the business, and the different skill sets that might be required from the next generation. Small businesses have a distinct advantage when succession candidates have spent much of their lives working in and around the business, but making sure that the ultimate successor understands his or her role in leading the company, and is properly trained to do so, is of critical importance.
Consider the tax consequences
Perhaps the biggest trap in succession planning is losing sight of the transition’s tax consequences. This is the one area where smaller businesses are at a distinct disadvantage, as the operational leadership of the business is often accompanied by significant ownership stake. As business owners begin to plan the transition to the next generation, often the first step to consider is passing ownership of the business in the most tax-favorable manner possible. Unfortunately, because succession planning is often subjected to a short time frame, the most tax-effective transition of ownership may be more difficult to execute. In addition, tax considerations must be made if the founders or historical owners desire to have some deferred components to the payout under the succession plan. Further, in the small business arena, related-party rules might impair the ability to transfer the business in a tax-effective manner. While it is critical that succession plans prioritize the identification and training of the right candidate to lead the business into the next generation, several tactics can be employed to make any plan more tax-effective, including the use of:
- Installment sale techniques to provide former owners with future stream of income.
- Stock redemptions to facilitate ownership transfer.
- Different stock classes or profits-interest partnership interests to meet strategic objectives.
- Gifting to transfer ownership to family members over time.
- Buy/sell agreements to limit transfer of ownership to desired parties.
Succession planning can be daunting. For small businesses, the need to strike the necessary balance between what is in the best interest of your family and estate and what is best for the business can make things even more challenging. However, putting a plan in place early can help ease the burden substantially. If you want to discuss additional specifics related to succession planning, and ways to mitigate the related tax consequences, contact the experts listed below at PYA, (800) 270-9629.
