When is the Right Time for Succession Planning?

Small business owners worry about everything that happens in their business. Payroll, inventory, cash management, personnel, production, quality, marketing, and profits are just a few things that consume the owner’s day. For many owners, these things carry over to their home life. The last thing they think about is retiring or, even worse, unexpected death. Unfortunately, this failure to plan for succession leaves the company vulnerable to failure or decreased valuation in the sale of the business. A succession plan is as important as a cash management plan or sales and marketing strategy. A succession plan is critical for the generational success and legacy of the family-owned business. 

Background of the Problem: No Success without Succession 

Small businesses represent a significant portion of the Gross Domestic Product (GDP). 90% of all US businesses are family firms, represent approximately 64% of the GDP, and employ 62% of the US workforce (Leibell, 2022). Small businesses are considered the backbone of the country. Small business owners can’t maintain ownership forever, though. Owners will plan to retire and will not live forever. 75% of business owners plan to retire in the next 10 years with $1.5 billion in assets (Hardy, 2022). Another problem is business owners’ reliance on their businesses for their livelihood. 93% of family business owners rely on the company as their primary source of income (Leibell, 2022). There is a significant concern if these business owners retire without having a succession plan.  

Succession Management: Finding the Right Fit 

Succession management is the process of finding replacement talent for the company’s leadership from either internal or external sources and ensuring they share the same vision as the current leadership (Odiachi, 2023). Many business owners choose to pass their businesses to family members like children, grandchildren, siblings, or nieces and nephews. This decision may not consider the talents and abilities of these relatives, which in turn may impact the success of the business after the business is transferred. 30% of family businesses survive past the 2nd generation, only 12% at the 3rd generation, and a tiny 3% make it past the 4th generation (Arambhan & Seetharaman, 2022; Leibell, 2022). There are many issues and concerns when considering a succession plan. 

Succession Planning Issues: Family Dynamics 

Succession planning is not an easy task. It takes collaboration and cooperation from many parties. One of the issues that happen when discussing succession plans is family dynamics. One dynamic is when the business owner wants to keep control of the company even if it risks the success of the succession (Leibell, 2022). Business owners spend most of their lifetime building the business and have difficulty relinquishing control of something in which they put so much effort. Family issues are the biggest problem in succession planning (Hardy, 2022). Resentments and sibling disputes are the most common family problems when discussing succession planning. Families bring their history and past issues to the discussion, making it nearly impossible to find a viable solution. 

Another issue is regarding gender. Most business owners will choose a male successor over a female successor (Arambhan & Seetharaman, 2022). This issue seems to be changing, but not as quickly as some would expect. Unfortunately, when the business owner is male, they prefer to pass the business down to male heirs rather than potential female heirs. These issues can damage family relationships and cause serious delays in completing a succession plan. 

Succession Planning Concerns 

Succession planning concerns should be considered when discussing a succession plan. White et al. (2004) identified transfer taxes, ownership and control, corporate structuring, and valuation discounts as succession planning concerns. Transferring business ownership is not a common practice of small business owners. Owners usually only transfer ownership once in their lifetime (Hardy, 2022). This inexperience with the transfer process opens the door to many problems. The valuation of the business is another concern because it is important to get the most value from the business built over a lifetime. If the business will be passed to the family, it is important to balance family and business relationships with the family members (Lu et al., 2022). There are a lot of problems and concerns when considering a succession plan. So do businesses really need one? 

No Succession Plan: The Worst Option 

What happens if no succession plan is in place and the business owner unexpectedly dies? Some genuine consequences happen in a worst-case scenario like this. First, succession completion could take years without a succession plan (White, et. al., 2004). This delay can negatively impact the business’ operations and profitability. Turnover could dramatically increase if employees feel their job security is in jeopardy. One of the most notable companies that did not have a succession plan was Microsoft. In 2013, the CEO of Microsoft announced he was stepping down, but they did not have a successor for the position (Fernandez-Araoz, 2021). The search took six months to find the replacement. The risk involved was extremely high since the wrong replacement would lose market share and profits. If it took Microsoft six months, how much longer would it take for a small business? How could such a large company be caught by surprise and be so unprepared? Succession planning does not happen by accident, but the need for a succession plan can happen suddenly. It takes work, but the benefits far exceed the costs. 

Succession Planning Process 

1. Communication 

The first step in succession planning is communication. Discuss succession planning regularly to ensure the plan is well thought out to ensure a smooth transition that aligns with the business strategy (Sorensen, 2023). These discussions will pave the way to setting up the plan and ensuring all stakeholders are on board. The discussions should not be limited to just family members. The business owner should be discussing succession with any potential successors and key stakeholders of the business. Business owners should discuss a clearly defined succession plan that involves non-family participation (Arambhan & Seetharaman, 2022). This reduces turnover and gives more involvement from employees not part of the family. Employees will feel like they have more stake in the business. 

2. Identify Potential Successors 

One of the next steps is to identify potential successors. Successors could be in the family, but they might not be the best options for the business. A flexible approach allows heirs to come from alternative sources if family heirs are not equipped to take the role (Buckner, 2021). This could be due to a lack of financial knowledge or business knowledge, or a lack of willingness. When choosing a successor, nonfinancial factors like reputation and family legacy are just as important as sales growth and profitability (Williamson, 2021). Successors should be given training, direction, and exposure to key stakeholders and clients to be fully prepared to take over the role without a negative impact on business operations.  

 3. Documentation 

The final step is to put the plan on paper. This is not as easy as it sounds, but it’s necessary. Documenting a plan makes the plan real and not just an idea. This can be done as part of the discussions or can be more formal by incorporating a formal team to ensure the plan is clearly defined. One suggestion is to set up a governance structure that creates a succession plan (Renuka & Marath, 2023). This will identify the key people responsible for following the succession plan to ensure its success. Many components must be addressed before the succession event, so preparation is the key to success. 

In a succession plan, include taxes, valuation, ownership, management, and corporate structuring. The transfer of ownership of the business is a financial transaction. There will be a tax liability based on the value assessed to the company. The business needs to be sale ready with the appropriate structuring to ensure the most after-tax cash possible. The business also needs maximum valuation and personal benefits to negotiate if the owner decides to sell to an outside buyer (Hardy, 2022). If ownership is to be kept in the family, then ownership succession can be done through estate planning. Ownership is not the same as control, and management succession will also need to be addressed if the family will not retain any management control (Leibell, 2022). 

Conclusion 

The idea of succession is not new. Business owners want to know that the company they worked so hard for will be able to provide jobs and opportunities for future generations of the family. The time to start planning for succession is now. Have the necessary discussions with those that will be involved in a succession event. A written plan makes it real and actionable when the time comes. A lack of a succession plan will set the company up for potential failure or a dramatic negative impact on the business. If succession planning seems too difficult, seek an outside company’s assistance to ensure the financial aspects of succession are covered. It is not a question of if succession happens, but when succession happens. Are you ready? 

References 

Arambhan, P. A., & Seetharaman, A. (2022). Perceptions of succession planning in family-owned businesses. Journal of the International Council for Small Business, 3(4), 337–349. https://doi.org/10.1080/26437015.2022.2098079 

Buckner, S., Jr. (2021). Succession planning strategies for small family-owned businesses. Walden Dissertations and Doctoral Studies. 

Fernandez-Araoz, C., Nagel, G., & Green, C. (2021). The high cost of poor succession planning. Harvard Business Review, 99(3), 98–107. 

Hardy, J. (2022). The careful planning for succession: Many owners just don’t know where to start. Business in Calgary, 32(11), 30–33. 

Leibell, D. T. (2022). Getting the family business owner to act on succession planning: Break it down into bite-sized pieces and identify and overcome certain key personal concerns. Trusts & Estates, 161(3), 20. 

Lu, F., Kwan, H. K., & Ma, B. (2022). Carry the past into the future: The effects of CEO temporal focus on succession planning in family firms. Asia Pacific Journal of Management, 39(2), 763–804. https://doi.org/10.1007/s10490-020-09748-4 

Odiachi, J. M., Sulaimon, A., & Kuye, O. L. (2023). Succession management: A proficient resource in organisational sustainability? Management Dynamics in the Knowledge Economy, 11(2), 112–127. https://doi.org/10.2478/mdke-2023-0008 

Renuka, V. V., & Marath, B. (2023). Impact of effective governance structure on succession process in the family business: exploring the mediating role of management succession planning. Rajagiri Management Journal, 17(1), 84–97. https://doi.org/10.1108/RAMJ-06-2021-0048 

Sorensen, A. (2023). How to improve the odds of a smooth CEO succession: Tailor your CEO succession planning process to your company’s specific needs and ensure long-term success. Directors & Boards, 47(4), 38–41. 

White, W. S., Krinke, T. D., & Geller, D. L. (2004). Family business succession planning: Devising an overall strategy. Journal of Financial Service Professionals, 58(3), 67–86. 

Williamson, G. M. (2021). Family- owned business leader succession planning strategies. Walden Dissertations and Doctoral Studies.