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  • Writer's pictureRic Armstrong

Creating a Succession Plan for Your Small Business

A small business succession plan outlines what should happen to your business should you retire, pass away, or become incapacitated. As the owner, your succession plan is closely tied in with your estate plan. This is because your personal share in the business (which may be 100 percent if you are the sole owner) is part of your personal estate. This business interest can be included in your Will, Trust, and other estate planning documents and can be left to an heir or heirs of your choosing. 

Many succession plans include buy-sell agreements when the owner does not have a family member to take over the business. Unless the business is going to be passed to an heir through the owner’s estate plan,  it is usually sold to a co-owner, an employee, or an outside entity.

It’s also important to draw a distinction here between business ownership interest and business operations. Your estate plan may address what should happen to your business interest when you pass away, but it does not necessarily dictate what should happen to the business and its operations.  

Key points to be addressed in a succession plan:

Operating agreement: An operating agreement is a legally-binding document typically used when multiple owners form a company. The agreement addresses who the owners are and how the company is managed, including financial and operational rules and provisions. The operating agreement should address items such as who should take over duties on a temporary basis, how long-term decisions are made if one of the owners are absent, and whether the surviving owners should buy out the deceased owner’s business interest.

Buy-sell agreement:  This is a pre-agreed upon sale between an owner and a third party. The sale is triggered by the death of the current owner, or another type of event. This trigger causes the ownership interest to be transferred to the third party. The price is agreed upon at the time of signing; it could be a fixed price or based on another valuation method such as fair market value. 

Will or Trust: You need to approach your ownership interest from both estate planning and succession planning. Your ownership interest is your personal property. This means that you have the option of using either a Will or Trust to bequeath your personal interest shares to an heir or heirs of your choosing. 

The way you structure your estate plan may or may not coincide with your succession plan. For example, one person could inherit both your business interest and your role as President of the business. In another instance, your heir could inherit your business ownership but play no role in the active management or operation of your business.  You could also direct in your succession plan that your business is sold should you pass away, and instruct in your estate plan that your heir inherits the proceeds.

Business Valuation: If you plan to sell your business, or allow your heirs to sell your business shares, then you’ll need to know the value of your business. There are many different valuation methods. Be sure to document what method should be used to ensure that your business value is calculated, documented, and updated regularly.

To liquidate or not to liquidate: If you were to pass away or retire, would you want the business to continue? Some owners simply want to liquidate assets and close the business. Others may want the legacy of their business to continue when they’re gone. If you choose the latter, you’ll need to choose a successor.

Successorship: A successor is the individual who will take the owner’s place. This can be a family member, a key employee, or other individual. You should also define the timeline under which the succession should take place. This could be a predetermined date, or a trigger event such as your death, disability or retirement.

Debt management: Most business owners have loans and lines of credit. When the owner passes away, the lending institutions have the right to force repayment of the loans. A solid succession plan should include instructions for how to manage debt, such as what funds or assets should be used.

Tax planning: A good small business succession plan can also minimize the impact of taxes. For example, the owner can take advantage of the Tax Relief Act or gift-giving exemptions to help reduce the tax liability. 

Standard operating procedures: Your plan should document your standard operating procedures (SOPs).  This is essentially a guidebook to how your business is run. It should include an organizational chart, operations manual, employee handbook, job descriptions, training, and critical meetings and processes.

Funding: Business transfers and sales require funding. It is extremely helpful if you lay out in advance how your succession plan should be funded. Ideas include a life insurance policy, a business loan, or seller financing.

According to current research, seventy percent of business owners have a succession plan. However, half of these owners have concerns about their selected successor’s ability to grow the business long-term. Over half are also concerned that the planned succession could result in family in-fighting.

Should you have any questions or concerns about Creating a Business Succession Plan, please reach out to Derek Saunders, Keith Strahan, or Richard Armstrong of our firm, shown here:


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