Succession planning essential for small businesses

Succession planning is critically important for large public companies with thousands of employees and stockholders. But it is no less

important for small companies with relatively few employees who depend on the venture for their livelihoods.

While large companies typically have board committees and/or staff members whose sole responsibility is to develop and implement detailed procedures for identifying potential successors both within and outside of the company, small companies usually have less structured practices. Such practices may be as simple as choosing an obvious candidate, such as the only child of the company’s founder, or perhaps at least on an interim basis, the most senior employee if the child is too young.

Passing the business to younger generations, may not work for all companies.

“Family-Owned Business Success: Leveraging Advantages and Mastering Challenges,” a report by the U.S. Small Business Administration, states, “Though inevitable, succession is often the least planned, and consequently, the most perilous event for a family business. History has shown that one in three firms will survive the transition to the second generation. Only 10 percent of the original group will survive into the third generation of ownership.”

Given the increasingly complex challenges facing small and large businesses – whether from government regulation, international competition, new technologies, rapid obsolescence of products, among other factors – simple procedures and searches limited to family or current staff may no longer suffice. In order for a business to have a future, serious issues must be addressed and answered, often with the help of a financial planner or adviser. Among the issues:

• If a family member is the obvious heir apparent, is the person really able and willing to handle the job? According to the SBA, it’s never too early to start grooming a successor from within the family. “By elementary school age, youngsters can stuff envelopes and help with office housekeeping chores. As they mature, their participation can grow accordingly,” the paper says, noting that it’s also a good idea for younger generations to get experience outside the family business before joining the company.

• If the obvious heir apparent is not the best choice, consider whether there’s another family member – one who was perhaps not previously considered – who is better able and willing to do the job well, not based on age, relationship, gender or education. According to the SBA, “Separation of family relationships and business is especially essential at this juncture. The decision must be based on qualifications, regardless of family dynamics.” A business owner also needs a backup plan in case a family member or other chosen successor fails to run the business appropriately.

• If no family member is able and willing to lead the company for the foreseeable future, business owners will have to decide whether to search for successors within the company, to launch an outside search or to sell their businesses.

It’s important, in this scenario to determine whether the most senior employee is necessarily the best-qualified candidate or if a younger employee would be a better prospect.

• If it is necessary to look outside of the business, owners should consider whether current employees who considered themselves to be eligible would be disappointed enough that there’s a risk of losing their experience.

• What sort of compensation and benefits package would it take to attract a suitable candidate? Can the company afford to offer it? If a compensation package were to involve equity, determine whether anything needs to be done to facilitate consensus among current owners to accept the arrangement. Business owners will need to determine the value of the business as part of any succession-planning exercise.

• Given the importance of retaining principal employees, plans must be made to A) properly communicate to them the rationale of finding a successor outside of the company, and B) to enhance compensation and benefits to keep them at the company.

“These key players need reassurance that they have a place after the incumbent retires,” according to the SBA. “Conversely, incumbents need to help them understand that they must enthusiastically support the succession process and the incoming leadership.”

Ideally, according to the SBA, family businesses should begin succession planning at least a decade before the owner expects to leave the firm.

This article was produced by the Financial Planning Association and provided by William O. Woody of Stovall Woody Associates. Woody can be reached at william.woody@axa-advisors.com.[[In-content Ad]]