You've decided to sell your business and name a successor. You've read part one of our How to Create a Great Legacy series, so you're equipped with the knowledge you need to value and sell your business. In part two, we're looking at some of the most common missteps business owners make when they start on the path to creating their legacy. (If you're ready for the series wrap-up, you can jump to post three, Putting it all together.)
More importantly? We're going to help you avoid them.
Fail to plan? Plan to fail
Owners know that their business lives and dies by this adage. Data shows that 20 percent of small and midsize businesses fail within their first year, and by the fifth year, 50 percent have shut their doors.
While it's impossible to predict every outcome — as the ongoing impact of the pandemic makes clear — business owners who take the time to consider as many potential paths as possible are better equipped to handle challenges as they occur.
When it comes to succession and legacy planning, meanwhile, it's easy to put the cart before the horse. You've already done so much of the hard work, from getting the business off the ground to carving out your target market, turning a profit, and creating a sales and service model that's sustainable. It's easy to get caught up in the idea of creating your legacy without considering the potential problems you may encounter.
As with like your business, however, success in your legacy depends on:
- Taking the time to consider potential areas of difficulty
- Identifying ways to handle these obstacles
- Taking actions that increase the likelihood of positive outcomes.
Here's a look at the top seven missteps — and what you can do about them.
1. Missing a clear vision
Succession plans focus on what happens after you leave a business — but have you considered if you'll still have any personal involvement with your business? Depending on your preference, you may want to leave the company completely behind, still receive regular updates, or have a hand in decision-making under certain circumstances.
With everything going on, you may forget to draft a vision statement. This is a way to clearly describe your vision for the business after you leave, and define the limits of changes that can be made immediately after your departure. While there's no requirement to draft a vision statement that gives you a say in changes that could significantly alter the company's future, this isn't something you can do after the fact.
If you leave without a statement in place, the new owner(s) are under no obligation to provide details about their plans or listen to your suggestions. As a result, it's worth taking some time to think about what role you want to play after you leave, and then codify this role to make sure you're prepared to make the jump.
2. Lacking the right business structure
Depending on your plans for succession, your current business structure can enable or inhibit the efforts of the new owners. For example, does your business currently use a C Corp or S Corp tax classification? In the case of a C Corp, the business itself pays taxes on its income, while owners pay tax on whatever salary they take. Under an S Corp model, meanwhile, the corporation itself doesn't pay tax — instead, owners report company revenue as personal income.
If your succession plan lacks the right business structure, it could cause problems for the new owners, especially if they're family or close friends. For example, while C Corps don't have limits on the total number of shareholders, S Corps can only have 100. In addition, C Corps can offer multiple types of stock, whereas S Corps can only offer one. When it comes to taxes, meanwhile, S Corp owners are only taxed once on the income they receive from the company, while C Corp owners are double taxed, first on the business side and then again on their personal taxes.
To help avoid business-structure issues, it's a good idea to sit down at the beginning of your succession planning to determine what type of structure best fits your business once you're gone.
3. Forgetting about family concerns
On paper, the idea of business succession often seems simple, especially if you have children or other relatives who are interested in taking over the organization when you leave. In reality, however, the choice of a successor (or successors) can cause significant familial conflict.
Consider a family with two children. The eldest is interested in taking over the business, while the youngest has their own career. Is succession as simple as transferring ownership to the eldest, or do owners need to consider selling a portion of the business to someone else and then providing this money to their younger child? Does the potential revenue of the business necessitate this kind of balance? Or does the stress that comes with owning the business offset the notion of the youngest receiving any compensation?
This can get even more complicated with extended families. When aunts, uncles, cousins, nephews, nieces, and in-laws are involved, does everyone who has worked at or alongside the business deserve some say in what happens next? Even if owners determine that a specific person is an ideal successor, will this lead to inter-family conflict?
A recent study from the International Journal of Environmental Research and Public Health puts it simply: "The uniqueness of family businesses, being the intertwining of the family and the business system, represents a double-edged sword for business families that strive for mental health at individual, family and business levels."
Bottom line? Whenever possible, it's better to address family concerns up front, rather than dealing with them after the fact.
4. Overlooking partner problems
Another common misstep is overlooking potential problems with other business owners. While in most cases you have the right to sell your shares to the person or company of your choice, it's worth approaching this transition with caution.
Why? If existing partners don't like your choice of successor, they make take steps to limit the scope of influence and responsibility held by the new buyer. If you push back on these steps, it could create a culture of anger and resentment that ultimately undermines the business and makes it harder for your succession plans to occur as intended.
To help avoid this issue, start a conversation with your partners when you first start thinking about succession. Talk to them about your plans post-business, who you might want to hire as your successor, and what that looks like for them. This makes it possible to draft documentation that benefits you, your partners, and your incoming purchaser before the changeover happens, rather than scrambling to put something in place as the sale of shares is underway.
5. Waiting until the last minute
This ties into our next pitfall: waiting too long to start your succession planning. Ideally, you want to start planning the moment you start thinking seriously about leaving. Why? Because over time, your succession plans may change.
For example, you might find yourself burnt out and wanting a change, which leads to the notion that selling your business in its entirety and leaving everything behind is the right choice for you and your family. If you immediately put plans in place and make the change, you may find yourself regretting the decision six months or a year down the line once your burnout starts to fade and your passion for the business comes back.
Reduce the risk of this pitfall by starting early and getting the help of experienced succession planning specialists, who, let’s face it, know this territory better than you do. Put simply, the more time you have to expertly plan, the better your chances of creating a succession plan that lives up to your legacy expectations.
6. Focusing on the short term
The interconnected nature of succession planning makes it easy to focus on the short term — on the challenges that are right in front of you, rather than the longer-term consequences of the decisions you make. Consider a basic business transition that sees ownership transferring from "X" to "Y" — from you to a family member or a partner. Simple, right?
Potentially too simple. Instead, you might want to consider an installment approach that sees the next generation of owners paying for the purchase of the business by using sales revenue. You could also include a default clause that sees ownership returning to you or a third party if the new owners aren't able to keep the business afloat or can't make their installment payments over time.
Taking a long-term approach to succession planning provides a more holistic view of how your decisions now could impact both the business itself and the members of your family as they take ownership roles or remain on-site to help new owners navigate key challenges.
7. Discounting tax complexity
There are only two certainties in life — death and taxes.
While business owners are often familiar with their tax obligations on a year-to-year basis, additional tax complexity arises when it comes to selling your business or initiating a transfer of ownership. In addition to state and federal tax laws, there may be international statutes that apply, depending on where your business operates, where your employees are located and where your revenue is primarily generated.
Discounting this tax complexity can lead to serious problems. For example, if you've run the numbers and come up with a solid valuation for your business, found a buyer, and initiated the transaction — but then discover additional tax obligations — you could end up with significantly less money than predicted, in turn potentially impacting your post-succession plans.
There's also a worst-case scenario here: unintentional tax fraud. If you forget to file taxes for a specific succession action, even if you don't realize that the law applies to you, you're still responsible for the outcome. Consequences range from immediate payment of outstanding taxes to payments plus significant penalties.
To navigate this pitfall successfully, it's best to engage professional help. Given the number of potential taxes — and tax exemptions — that could apply in your specific case, it's worth taking the time to sit down with a tax expert and understand exactly what taxes will apply and how much they will cost when you sell the business. These professionals can also offer advice about how best to structure and sell your business to minimize the tax impact you face.
Staying the course
Your legacy is more than just what you leave behind. It's a testament to the work you've done and will continue to do even as your role in the company shifts. After investing so much of your time — and yourself — into the business, it's critical to stay the course, to ensure that the legacy you want to leave is the one that comes to fruition.
In summary, keep your legacy plans on track by planning for common missteps. Instead of waiting to see what happens and dealing with the consequences as they arise, make sure you're prepared with a clear vision statement and a business structure that supports what you're trying to do. Keep both family and current business partners in mind when making your decisions, and play the long game when it comes to both preparation and execution.
Finally, always assume the worst when it comes to taxes — plan for potential problems at local, state and federal levels to ensure you're not surprised when the succession process starts in earnest.
Need help ensuring your legacy goals become a reality? Check out part 3 of our series: Putting it all together.