What is business succession planning?

A succession plan outlines what will happen when the owner of a business decides to leave their leadership role, says Entrepreneur.com. It's essentially a road map for how the business will navigate this change and how its assets will be treated in the process. Think of it as a plan for transitioning leadership, either by selling the business, passing it onto heirs or turning it over to employees.

The plan may include details about the value of the business, the future division of responsibilities, agreements between partners and heirs and any other factors that can affect the company's future.

An effective succession plan gives the owner a voice in the future of the business — helping to ensure that it will operate smoothly, the appropriate people inherit the company and, if you're selling the business, that you get a fair deal, says Inc.com. Having a plan in place may help minimize estate taxes and expenses, while maximizing the wealth passed onto the next generation, according to Entrepreneur. Designating someone to fill your role may also provide stability for the company, employees, customers and family members, particularly if the transition is the result of an unexpected event.

A succession plan is particularly important for a family-owned business, explains Entrepreneur.com It's important to decide whether a spouse or children will take over the business. Maybe only some of your children are interested in taking on the role, or perhaps you have a business partner who can manage the company while your relatives retain ownership. There are a lot of decisions to make, and a lack of planning may leave business partners and family members squabbling through tough decisions regarding the future of the business.

Without a business succession plan, you may be exposed to five significant risks, according to Coastal Community Bank.

1. A leadership void
2. A loss of business value
3. A decline in brand reputation
4. A struggle to grow or remain competitive
5. Legal or financial troubles

Essentially, if you haven’t identified and trained a successor, a lack of leadership and clear vision for the future could see the business begin to falter, causing it to fall in value and become less trustworthy both in the eyes of the public and with employees or partners. Additionally legal disputes or unplanned-for financial responsibilities could cause major problems.

Here are some critical parts of a succession plan. Please note, components could vary depending on the size of your business, whether you’re passing the business down or selling to an outside party and other factors unique to your situation.

Identifying successor candidates

No matter the reason for the transition, business owners will almost certainly want their replacement to treat the business  as well as its clients, partners, and employees  with the same level of passion, care and hard work they used to build it. Leadership can make or break a business, so finding the right successor is key. Identifying multiple candidates as early as possible can help.

Defining roles and responsibilities

Whether you’re passing down your business to a family member or selling it to an outside party, consider the roles and responsibilities. April Sabral, a member of Forbes Coaches Council, recommends identifying what skills are necessary for a new leader. For example, do they need to be well-versed in finance, or will they be speaking in public as the face of a larger brand?

In addition to defining traits a new leader should embody, Forbes Coaches Council also notes it could be important to identify other people’s roles and responsibilities during the transition period. For example, does the recruiting team need to help identify a suitable outside hire to run the business while loved ones simply retain ownership? Or, could it be wise to create a hiring committee made up of employees, board members and key clients?

Establishing a timeline for transition

Because businesses are unique, there isn’t a set timeline for when a business owner should start planning for transition or how long it should take for the succession plan to play out. However, Forbes notes that while a five-year timeline for planning might be good, it’s even more ideal to plan earlier if possible.

Planning as early as possible has its advantages. For example, Forbes points out that you might need to step aside sooner than originally planned or your first-choice successor could take another job. So, getting a head start can help you address potential hiccups or unexpected changes. Additionally, having a clear timeline with checkpoints along the way can make sure everyone and everything is ready as you begin to step back and ultimately step away.

Legal and financial considerations

Do you need a carefully crafted buy-sell agreement? Could there be a dispute between family members about ownership or who is controlling day-to-day operations? Considering all the potential legal complications can help avoid costly issues.

Additionally, both passing a business to a successor and selling to an outside party come with major tax implications, according to ADP. Therefore, it’s important to consult knowledgeable financial experts to make sure all parties are getting the best financial deal.

How do you practically create a succession plan? Here are some basic steps to help guide you, but please note these could vary depending on your unique situation.

1. Identify requirements for potential successors

Consider what skills are required for the role. What are the day-to-day responsibilities? What are the must-haves, and what are the nice-to-haves?

2. Evaluate potential successors

Make a list of potential candidates, and to find the right one, evaluate them based on the answers to the questions above. Forbes Coaches Council notes you want to make sure their skillset is up to the standard required for the job and that they align with the company’s vision. Additionally, evaluate whether they can fulfill any immediate business requirements around the time of the transition. After that, you can assess which candidates can add something new to the company’s culture or have fresh ideas that can push the business forward.

3. Outline ways to help candidates develop necessary skills

After you’ve identified potential successors, you need to help them cultivate their leadership abilities and develop skills related to their potential future role. Figure out ways you can help them prepare so they’re ready to take over when the time comes. TalentNeuron suggests creating personalized development plans.

4. Develop a transition timeline

When do you plan to leave your current role? How long will it take to train your potential replacements? Will you gradually phase out of your current role over a period of time? Consider these questions and others to help develop a timeline. Remember, Forbes notes that preparing as early as possible, and as much as possible, is ideal.

5. Communicate the plan to stakeholders

There might be a temptation to do succession planning in some level of secrecy, but the Academy to Innovate HR says communicating in a transparent manner with stakeholders — at the appropriate time — can help manage expectations and align the workforce.

6. Implement and monitor the plan

After you’ve developed your plan and communicated it out, it’s time to put it into practice. Make sure to monitor each component carefully and don’t be afraid to adjust the details or timeline if necessary.

Roughly two-thirds of family-owned businesses don’t have a documented and communicated business succession plan, according to Teamshares. Many business owners may find it difficult to start succession planning for several reasons, including but not limited to:

• A resistance to change. Entrepreneur.com notes that many people’s identity can be tied to their life’s work, and as a business owner who has spent so much time and effort building a business, it can be hard to let go of emotional attachments.
• An assumption they have plenty of time. Some business owners don’t think they’ll be selling or stepping aside at any point in the near future, meaning they don’t view succession planning as a priority.
• A lack of resources. An ASIS International survey revealed 31% of business owners believe they don’t have the time or resources to develop a succession plan.

Even after developing a plan and putting it into place, other challenges can still arise. Successor candidates you picked out can leave, or your timeline for stepping away or selling might need to change. Planning for contingencies and evaluating regularly can help you overcome these difficulties.

Whatever the future plans are for your business, every succession plan must comply with the Internal Revenue Service (IRS) tax code. Entrepreneur says getting a business valuation is a good starting point, as it will give you an idea of how the IRS values your company. From there, you can start to determine the potential tax liability of selling or transferring ownership of your business.

It's a good idea to work with a tax professional and attorney so that you understand the exemptions, exclusions and deductions that may affect the financial impact of the business transition. For example, if a family member is taking over the business, the Small Business Administration notes that your successor may be responsible for estate and gift taxes. Or, if you sell your company, you may have to pay a capital gains tax — a federal tax on the profits you receive from selling an asset, such as a business or stock shares, says The Balance.

Whether you're just getting your business off the ground or you're looking to retire, having a succession plan in place is important for small businesses. Having these plans laid out can help your business move through changes and increase the likelihood that your business will continue to succeed for years to come.