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For many business owners, their company is their single largest holding and the key to a successful retirement. Planning well ahead of departure will help ensure there is a successful exit. A solid succession plan helps the owner get the most out of this asset at retirement, disability or death.

For a business owner, when and how to transition out of the business at retirement, death or disability presents many decisions and opportunities. The decision often centers on one of three common outcomes:

  • an internal sale to other owners, key employees, or family
  • an external sale
  • occasionally a liquidation of the business assets

Modeling different types of outcomes through HKFS’s Guidance Planning Strategies (GPS) process can help the owner with this decision. As with any financial plan, it is important for the owner to design their succession plan around their goals and what is important to them. They may want to sell internally to family or employees in order to preserve the culture of the firm or the livelihoods of other stakeholders involved. They may instead be interested in selling externally to command the highest price, thereby securing their financial future or avoiding what could be a lengthy buyout process. Lacking a discernable market or other alternatives, they may liquidate business assets and sail into the sunset. Regardless of the type of transition, careful planning must take place well in advance of retirement. When owners fail to plan for succession, the outcomes can be less than favorable.

One of the keys to a successful transition is a formal buy-sell agreement. A buy-sell agreement makes it clear who will take over the business, regardless of the path an owner chooses or is forced to take. If a purchase is involved, the sale price and purchase terms are also clearly outlined, relieving some of the stress. In other words, a well-crafted succession plan and buy-sell agreement aims to benefit everybody—the departing owner and their successors.

Selling to Key Employees

If maintaining the company culture is a priority, selling to existing owners or key employees is generally more desirable than to an outside buyer. If there are multiple owners in the company, the partners will draft a mutual agreement that, in the event of one owner’s untimely death or disability, the remaining owner(s) will agree to purchase their business interest from their heirs. There is typically a buy-sell agreement, secured by life insurance for each owner. This provides liquid proceeds to facilitate the buyout. If the owner decides to sell to key employees, identifying those key people who have the experience and ability to run the business in the owner’s absence can be difficult. This should take place well ahead of retirement to ensure there’s enough time to train and coach people up to the levels required for a successful transition. A common drawback to key employee succession is money. Just like selling to a co-owner, a key employee succession plan requires a buy-sell agreement. Employees will agree to purchase the business at a predetermined date, or in the event of death, disability or other circumstance that renders the owner unable to manage the business. Owners may also choose to give ownership to the key employee ahead of departure. This helps retain the key employees. Most employees aren’t in the financial position to buy the business they work for. A financing arrangement can be detailed within the buy-sell agreement. Insurance can be used to fund the buy-out in case of premature death or disability.

Selling to Family Member/s

Having family members involved in the business can also provide for a natural extension of the business. This is a popular option for business owners who have children or family members working in their organization. A properly drafted buy-sell agreement is important if some family members are involved in the business and others are not because it outlines the distribution of ownership and business operations. Having a buy-sell agreement funded with life insurance can help ease the burden of an unexpected transition for the business and family members.

Selling to an Outside Party

Selling a business to an outside party can be the best option to maximize the selling price. Owners should prepare the business for sale well in advance; hire and train a great general manager, formalize operating procedures, and get all company finances in check. Make the business as stable and turnkey as possible so it’s more attractive and valuable to outside buyers. The main drawback to an outside sale succession plan is the unexpected: New owners can have a different philosophy and management style that competes with the old company’s culture. The business’s mission could pivot, staff could change, and customer relationships could dwindle. Selling a business in order to retire will leave the old owner much more detached from the business with an outside buyer, as opposed to a family member or key employee who may still seek advice. Additional stress can take place if the old owner stays on for a lengthy transition period.

If the company is branded under the owner’s name, selling could potentially be more challenging. Buyers will need to rebrand and remarket, and as a result, may not be willing to pay full price. As with the other types of arrangements, a buy-sell agreement is needed. Depending on the buyer’s capacity, the seller may need to back up the agreement with financing.

Transitioning out of a business can be difficult operationally, as well as emotionally. Starting the transition process too late, or without the proper expertise, can increase the likelihood of a poor outcome for everyone involved. Most successful transitions are planned years ahead of time and strategic goals are set along the way. Proper planning, including a formal buy-sell agreement, allows for a seamless transition for the business and the owner(s). If you’re considering your options, please talk to your CPA advisor or HKFS financial planning consultant. We’d love to help you.

James Milford, CFP® contributed to the creation of this article.