Advisor Q&A

Succession Planning for Business Owners

Q&A with Chris Sorrow, CFA®, MBA

How can succession planning help business owners?

I am always amazed by how many of our clients are private business owners. There are so many great advantages of owning a business, and speaking as a private business owner myself, I really enjoy the control, flexibility and the personal satisfaction I get from working with my business partners and colleagues. The two drawbacks of a private, closely-held business, however, are that the value of the firm usually or predominantly resides in the business owner themselves, either in the form of intellectual property or key business relationships, and there is usually not a liquid or observable market for the business itself. Both of these present challenges when it comes time for business owners to monetize their interest and ultimately exit the business. A succession plan helps business owners develop an exit strategy in advance, allowing them to transition the business in a way that maximizes their financial interest and emotional objectives.

What are the key elements to a succession plan?

It is not uncommon for the majority of a business owner’s net worth to be tied up in their business. For that reason, a succession plan usually goes hand-and-hand with the business owner’s own estate plan. If you think about it, there are only five ways for someone to dispose of a closely held business: (1) a sale to outsiders but the company remains private; (2) going public; (3) a sale to insiders but the company remains private; (4) testamentary disposition; and (5) liquidation. Each of these has different tax implications for the estate, and for that reason it is important to know far in advance how to structure the succession plan in order to minimize the tax impact on the estate and potential successor, while maximizing the value to the business sellers. If an owner is relying on the sale of their business to provide for their financial security during retirement, then obviously it is important to understand what the company is worth and what the key drivers are of the company’s value. One of the first recommendations we make is to get an independent valuation completed. A valuation works in concert with the succession strategy, providing a cost basis in the case of perhaps a gifted transfer, or a defensible negotiating position in the case of a sale to an outsider. Beyond that, the elements of a succession plan are really dependent on what the business owner is trying to accomplish.

When should a business owner develop a succession plan?

We tell clients to think about succession as a regular part of their overall strategic plan – while they are still active in their enterprise. If your wait until you’re near retirement, you may miss out on opportunities to teach and train a successor, to pass along your vision, and to share the benefit of your experience and knowledge. You also lose out on the opportunity to maximize the value of your company. You are better able to assess longer term investments and are more flexible in targeting key value drivers knowing that you have a committed, and sometimes contractual, succession plan in place.

Should business owners tell their employees about their succession plans?

Succession plans typically consider the importance of key employees, and we encourage owners to communicate their intentions in advance of the succession action. Uncertainty about what may happen in the event of a transfer may unnecessarily put you at risk for losing your best employees, and it can have a negative impact on attracting the best talent. Furthermore, in cases where the succession is occurring among family members, communicating your plans to all the family members can help minimize potential discord.
Many business owners will eventually need to determine when will be the right time to step out of the business and how they will do it. A little business succession planning ahead of time can ensure the continuation and growth of a business, prepare for tax obligations, and make the ownership transfer as smooth as possible.

Christopher T. Sorrow, CFA®, MBA
Christopher T. Sorrow, CFA®, MBA
Vice President


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