Succession planning for your small business

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Sooner or later, most people retire.

More and more small-business owners are inching closer to retirement age, according to recent stats from the U.S. Small Business Administration that report more than 50 percent are older than 50.

In Iowa, this means at least 26,500 small business owners — those with 20 or fewer employees — have come to the point when they need to decide what’s next for their business.

The Greater Des Moines Partnership reports that 40.3 percent of family-owned businesses in central Iowa are looking to retire in the immediate future, but 47 percent of those do not have a successor lined up or in place.

It’s a problem that leaders have come together to address through the Succession Planning Advisory Network, a task force of the Greater Des Moines Partnership. The group will examine ways to address an aging business
population and the future of those businesses.

“We know the business community is graying in Iowa; by that, I mean getting older,” says Kevin Lentz, a founder and partner of Performance Marketing in West Des Moines and a member of the taskforce.

Experts say a written succession plan is the answer for most business owners about what will happen to their business after they retire or die.

“Business owners will sometimes have in mind what they want to happen, but they’re so busy working in their business that they don’t have time to see their succession plan or to plan it out,” says Erin Herbold-Swalwell, an
attorney with Brick Gentry P.C., which handles succession planning for business owners.

A business succession plan is comparable to a disaster recovery plan, says Dick Rue, a former senior vice president and chief financial officer of ITA Group Inc. in West Des Moines who now assists businesses with succession planning.

“Succession planning in business, especially family owned, is just as important as estate planning is at the personal level,” he says. “If you have a small business and you’re not thinking about the succession of the business, the likelihood it will maintain or sustain after death or disability of the primary owner is very slim.”

Here are several steps to consider:

1. Should I have a succession plan?

Lisa Shimkat, the state director of the
Iowa Small Business Development
Centers, says business owners should
create a succession plan from the day
they open their doors.

If you want your business to continue, then the short answer is yes.

“Typically, only about one-third of businesses actually have a business succession plan,” says Lisa Shimkat, the state director of Iowa Small Business Development Centers, which has an office in Valley Junction. “It’s really hard for some businesses to talk about ‘What happens when I’m gone’ because the business is part of them; it’s an extension of them.”

It’s important to remember that a business succession plan isn’t just about mortality, she says. It’s about the future of the community, as well. Many local organizations, schools and civic organizations depend upon small businesses for their support with after proms and other fundraising events. If those business owners don’t have a plan for their future, the business may fold and have a negative effect on its employees as well as the greater community.

“It’s truly important to the sustainability of the community,” Shimkat says. “There’s a lot of secondary effects that go beyond what we see.”

Creating an exit strategy also will help the business owner ensure he or she has enough money to retire and during retirement. It will also help prevent potential strife within the family after the business owner has died, Herbold-Swalwell says.

“I think it starts when you organize your business,” Lentz says. “It sounds cliché, but some people don’t do it because they don’t think they’re going to need it. Do it when you create yourbylaws. That’s more important when you have family or bylaws involved. You can leave behind a really messy situation for folks if you haven’t
planned.”

This can include plans for disability of an owner or if the competitive landscape of the business changes, all the way down to planning a successor of the business and grooming that individual if it is someone from within the
company and ensuring prospective owners are able to financially take over the business, he says.

Business owners who are reluctant to pay their employees well or give them some type of ownership stake in the company put their employees in a position where they don’t have the resources to buy the business, Lentz says. Then the business owner has to start over with finding a successor, which can contribute to the failure of the
business.

2. What steps do I need to take?

On the day the business opens, the owner should have an exit strategy, Shimkat says.

“You don’t know what tomorrow will bring,” she says. “You need to be prepared, and you need to prepare those
around you.”

Gather input from numerous parties that include the business owner, their family members/heirs, accountants,
attorneys and other estate planners.

It’s important that business owners know whether their family members or heirs have any interest in taking over the business rather than make assumptions. There is a shift in the ownerships of the family business in Iowa, Shimkat says. There are more and more individuals within the “next generation” who aren’t following in the previous generation’s footsteps; they’re taking jobs in other industries.

“The No. 1 step is communication,” she says. “You can’t assume anything. You can have an employee who has been working there for 20 years and assume they want to buy in, but that might not be their plan. A family member might want to step in, but you don’t know this unless you communicate.”

Enlist the help of experts. No plan should be created without advice. There are firms that specialize in family business and business succession planning, according to The Balance, a website that provides financial advice to business owners. These individuals can guide the business owner through the entire process and mediate any issues that may occur within the family or from involved parties.

Rena Striegal, president of Transition Point Business Advisors in West Des Moines, helps business owners prepare for their future by discussing the future hopes, desires and values of the owner(s); ownership interest in the company; the company’s financial picture; and how this ties into the personal financial planning for the owner.

“The goal of the professional should always be to meet the needs and desires of the transitioning owner,” she says. “What will help them get what they want out of their business? Legacy? Cash? Preparing a space for their heirs?

In addition to an attorney, a certified public accountant and certified financial planner — Striegal emphasizes the
word “certified” — will help with any financial components such as stocks, revenues, cash flows needs, tax
consequences and more.

Lentz and his partners worked with an attorney, accountant and banker to include their succession plan into their
bylaws when their company was founded in 1999. He knew a plan for the future of the company was important because multiple partners were involved and based on past experience.

“I had seen firsthand some of the good, the bad and the ugly,” he says. “I knew in our situation with some partners involved, we needed to have all of these things in place.”

More than 70 percent of family owned businesses do not survive the transition from their founder to the next
generation, mostly because of family discord or taxes — more on the second, later — according to The Balance.

A succession plan will manage any potential transitional issues that could occur among family members. It will also take an honest look at family members and whether they even have the skill set to run a business.

A lawyer can ensure the plan has the proper legal structure to stand up to possible dispute. An accountant will provide factual numbers from which to base the value of the business or the amount of money the business owner needs for retirement.

Business owners can contact the Iowa SBDC to receive help, Shimkat says. The organization has a checklist of things for business owners to consider as part of their succession planning in order to prepare their business for the future. This includes monitoring industry trends to prepare the business for the new owner, updating pricing information for products and services, phasing out and removing obsolete inventory, updating all employee records and client accounts, and leaving complete records of vendors.

Finally, business owners need to make sure the final succession plan is communicated to all parties who will be affected by the sale or transition of ownership.

3. What does the plan include?

Dick Rue, a former senior vice president and chief financial officer of ITA Group Inc. in West Des Moines, now assists businesses with succession planning.

Any succession plan will have three components, Striegal says: Who is going to own the company? Who is going to manage it and make the decisions? What will the governance structure look like?

Many plans leave out the final component, which is important, Striegal says, because most business owners leave money in the business in order to support it, and that needs oversight.

The succession plan also will set a future goal for the business: Does the owner want to have more money for retirement? Does he or she want to leave the business to their children?

The plan will cover all details of the transfer of the business to its new owners from human resources to the financial details. It will take into consideration who will oversee the business. The business owner should consider the strengths of all possible successors in order to determine what will be best for his or her business. The management of the business may be different from the ownership, and the plan will spell out the details.

The sooner a succession plan can be written, the better, Shimkat says.

“Just because you talk about succession planning doesn’t mean it has to happen tomorrow or that you’re giving up on the business,” she says.

Some business advisers recommend an exit strategy be built into the business plan, according to The Balance. At least five to 10 years in advance can give enough time to put all parts in place and to ease the transition.

A plan should definitely be in place by the time the business owner is in her or his late 40s or early 50s, Herbold-Swalwell says.

Any transition of the business should allow for time to train the new owners and ensure it is as smooth as possible for all employees. If the company has investors or other stakeholders, they will need to be notified of the change in ownership before it occurs. Clients will also need to be informed of the change, and the business
owner will have to devise a strategy to make that happen.

Rue says 18 to 24 months of planning and lead time can get a plan in place. More time may be needed if the owner doesn’t yet know who will take over the business.

“The important thing for any business owner to recognize is if you don’t give enough lead time that trying to sell your business in a fire sale atmosphere you’re never going to maximize the potential of that business,” Rue says.

Performance Marketing’s succession plan takes into account if a partner wants to leave the company or is fired, as well as if someone becomes disabled or dies. There are provisions in place to buy out partners’ shares and how to determine the value of the business.

Lentz says he’s learned through the years how valuable it was to have a succession plan in place from the beginning. Bits and pieces of it have been used as partners have been eliminated and added to the company. The plan also has been updated as the business has grown.

“I thought it was going to be set it and forget it,” Lentz says. “As the business evolves and goes through cycles, you need to continue to adjust.”

Striegal agrees that succession planning is ongoing, and that business owners need to reevaluate their plan as soon as change is on the radar.

4. What are my options?

Any plan will take into consideration who the successor of the business will be and when the owner wants to leave the business — whether this is through retirement or death, experts say. There are a variety of options for business owners to consider:

• Transfer ownership to a family member either while still living or through an estate.

• Sell the business outright. This can leave a business owner with cash on which to live or to pay taxes that could be associated with the sale such as transfer or capital gains taxes. The new owner could be a larger company of the same type that wants to absorb the smaller company and take over its business and clients; an investor who wants to own the company but not run it; or an owner operator who will both own and operate the business.

• Transfer the business with a buy-sell agreement, which prearranges the sale of the business with the owner and a willing buyer. This allows the business owner to keep control of his or her interest until an event stipulated in the contract such as death, disability or retirement. The price and sale terms are prearranged.

• Create a private annuity with an interested buyer in which they receive ownership and agree to pay the  business owner periodic payments for a set period of time.

• Sell to an existing management member, which would include a buy-out plan and timeline of the succession.

• Form an Employee Stock Ownership Plan (ESOP). Experts say other options exist, including self-canceling installment notes, selling to a venture capital group, or the creation of family-limited partnerships, which is why a business owner needs to make a plan that includes all of those who are involved and make sure that the plan is recorded.

In any scenario, there needs to be a clear cut deadline for when the seller will exit and whether the buyer will retain the seller for a pre-determined period of time to assist with transition, Rue says. All plans also need to be in
writing and reviewed for legal standing. Iowa SBDC worked with one business in which the father was going to transfer ownership to his daughter, she says. The daughter was a recent college graduate and didn’t have the
cash or credit to finance the loan. The business owner worked with SBDC to set up a graduated succession plan to transfer ownership to the man’s daughter. By year three, she owned 30 percent of the company and had the collateral she needed to purchase the business from her father.

SBDC also connects business owners to aspiring entrepreneurs — similar to what the Parrish brothers did for themselves — who are graduating from college and want to own and/or operate a business.

“We’re trying to encourage them to approach business owners and encourage business owners to do the same — to reach out to college programs,” Shimkat says. “This might be the person you transition to.”

5. Are there any implications to consider?

A financial adviser, certified public accountant and an estate planning attorney can help a business owner work through any potentially adverse details that may occur with the sale or transfer of business ownership. If the business is going to family members or children, the owner will want to transfer it at its fullest value while limiting any potential income, gift or estate taxes, planning experts recommend.

Most family members will be safe from the estate tax under the new federal tax plan which makes gifts up to $10 million per individual tax exempt. These amounts will increase each year to account for inflation. In Iowa, the gifting of property to a spouse or children is tax exempt. The Iowa Department of Revenue also reports that no taxes are due if all of the property of the estate has a value of less than $25,000, nor is there a tax on annual gifts in the amount of $13,000 or less.

Transferring portions of the business over time may keep a significant portion of it free from tax. The disadvantage is that it takes more time to transfer the business to the next owner.

Finally, Herbold-Swalwell says the family needs to keep in mind any legal fees it may have to pay in light of an agreement about the business or its assets.

“I do see an increasing amount of family feuds happening when the plan isn’t communicated clearly or there is not plan. It’s a sad situation when your heirs have spent money fighting and paying legal fees,” she says. ♦

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