Monday, April 21, 2008
The Sad Sorry Truth about Small Business Succession Planning
Succession planning refers to your plans for your business if youre no longer able to operate the business. Succession planning plans for the day you step away from your businessperhaps because you retire or pass away or become disabled.
The Default Succession Plan
While people often assume they can sell their business, thats regularly incorrect. In fact, for many of the business owners reading this article, the implicit succession plan should be that the business will be shut down when the owner-operator leaves. That assumption is often the only one that makes sense in the case of very small businesses.
Why? Well, its frequently the case that such businesses cant be easily acquired and then operated by someone else. A consulting practice, for example, that relies on your network of contacts and business experiences probably cant be sold to and then operated by some other consultant. A part-time crafts business that relies on your artistic skills cant just be taken over by your neighbor or daughter.
The Importance of Communicating Your Plan to Family Members
Nevertheless, you ought to reflect for at least a few moments on the issue of succession planning. You probably want to communicate your ideas and thoughts to your heirs. I dont think you should count on, for example, a son or daughter taking over the family business. Thats not fair to them or their families. But before a decision must be made, you and the other people involved in any succession plan should objectively think through the question, What should we do with the business when he or she leaves?
Two Tips for Practical Small Business Succession
Two other points concerning succession planning of small businesses should be made: First, many small businesses will cost money to shut down and liquidate. If thats the case with your small business, you should include those costs in your final expenses. You may want to bump up any life insurance a bit to include these costs.
A second important point is that many small businesses arent worth that much more than their liquidation valuethe cash that the accounts receivable and any other assets can be sold forafter you adjust the profits for a fair salary to the owner.
For example, if a business makes $60,000 a year and a fair salary for someone with your skills doing what you do for the business is $50,000, the business profits equal $10,000. In other words, the business doesnt make $60,000: an employee (you) makes $50,000 and the business makes $10,000. The business profits determine the businesss value.
Small companies that can be sold are often worth two to five times their profits. That means the business that made you $60,000 but really produces adjusted for a salary profits of $10,000 is perhaps worth as little as $20,000 (2 x $10,000) and probably only as much as $50,000 (5 x $10,000). These amounts are probably not all that much more than the liquidation value.
Summing Up Small Business Succession Plans
Given the above discussed succession planning factors, you typically dont want to assume that your business is a major asset that your heirs can liquidate for cash or can operate to produce income. Instead, you want to assume your heirs will need to shut down the businessand you need to include the costs of shutting down in your estimates of final expenses.
About the author: CPA Stephen L. Nelson wrote the bestselling business planning book MBAs Guide to Microsoft Excel and the downloadable do-it-yourself corporation books Incorporating a Business in New York,
