Building a successful business is hard, really hard. After years of sleepless nights and constant pressure and accomplishing what 8/10 of business owners can’t, you’ve created a profitable, lasting business. You may enjoy the fruits of these labors for years.
But what next?
Although most people won’t admit it, time tends to age us. Stepping away from a business is almost as hard as getting it started in the first place, which is why it’s often not planned for until something forces it to happen. Whether it’s planned for or not, it’s inevitable.
Inadequate succession planning is costly in more ways than one. Some sort of plan, even just an outline, can be all an owner needs to avoid unnecessary and avoidable pain. Be proactive.
Valuing Your Business
Before jumping into the specifics, we first need to address the elephant in the room: valuation. Assuming a business is worth more than it is can make it impossible to sell. Although it’s extremely difficult because of a deep emotional connection, owners must stay objective and pragmatic during the valuation process.
At the onset of the process, begin by placing yourself in the shoes of a potential buyer: Ask yourself, “What would you determine the business was worth based on the facts of the market and current financials?”.
To ensure the valuation process is as objective as possible, consider hiring a third party appraiser. This appraiser can tell you which specific metrics are important in your line of business and derive multiple valuations based on those metrics. Most frequently, appraisers will use the Cost-Based, Income-Based, or Market-Based Approach (or some combination of the three) to valuation.
Once the valuation is set, it’s time to divest. Here are three of the most common ways business owners transfer ownership of their businesses.
- Gift to Heirs
Many business owners assume their children will take over the family business, regardless of having any discussions about the topic or not. Unsurprisingly, many are shocked to find their heir has no desire whatsoever. This isn’t true for all, however, as many kids jump at the opportunity to take over their parent’s successful enterprise.
According to Deloitte, just 30% of family-owned businesses survive into the second generation, 12% into the third, and 3% beyond that. This means, a child needs not only the desire to take over the business, but the aptitude as well. This can lead to tricky situations and tough conversations, especially if more than one heir is involved.
Additionally, the taxes involved in passing on a business can be massive, potentially making it impossible to pass on a cash-intensive business. Currently, individuals can give away up to $11.7 million ($23.4 million for married couples) without triggering a gift or estate tax. If the combined value of your business and estate is more than that, taxes can reach 40% on any amount exceeding the limit.
- Sell to a Family Member, Friend, or Colleague
Not everyone can afford gifting their most valuable asset to their heirs, or simply choose not to. The obvious hurdle when it comes to this method is the lack of capital heirs may need to make the purchase outright.
Instead of a lump-sum purchase, consider seller-financing. In this scenario, you act as the bank financing the purchase of your business. In addition to allowing for the buyer to use business profits as payments over a set number of years, it also provides steady income for you (if you can afford to delay the payments). Plus, it limits the tax burden occurring in any one year.
If selling to heirs isn’t an option, considering using the above steps to pass the business off to partners or key employees. Many of these people know the entire operation almost as well as you, contributing to a smooth transition for you, your employees, and your customers.
- Sell to a Third Party
The final option will most likely be the one with the cleanest exit, passing off all of your responsibilities with the sale. It’s also the most likely to bring the highest price tag and the lump sum payment, if you choose to do it that way.
The third party appraisal that was performed will now be especially useful in helping to dissociate personal feelings from objective facts. Selling to an outsider can be complex and time consuming. Even more than the others, surrounding yourself with a team of professionals (brokers, accountants, lawyers, and estate planners) to aid in the sale can be hugely beneficial for bringing in the best buyers and ensuring a mutually beneficial sale.
So, What Now?
Thinking about and being proactive in establishing a plan is the best way to ensure successful divestiture when the time comes. It can save you time, money, relationships, and a lot of potential stress. It also makes sense to perform your succession planning in conjunction with your general retirement planning, as the two will likely go hand-in-hand.