Succession PLanning

Business Owners and Baseball: Pitching Succession Planning

How advisors can help their clients ‘think through the game’

by John Going, CFP

Mr. Going, of Going Financial in Houston, TX, is an Investment Advisor Representative of and offers securities and advisory services through Lincoln Financial Securities Corporation, Member SIPC. Lincoln Financial Securities Corp does not offer legal or tax advice.

Prepare, create, grow and retire – a natural progression that exists in many facets of life. Take baseball for instance. Every game requires a succession plan. The starting pitcher sets the pace for the game and hopefully positions the team for success early on. If all goes as planned, the starter can retire after the seventh inning and the relief pitcher comes in to finish the game and ensure success for the team and all of the fans.

Much like in baseball, small business owners, including physicians and medical professionals, set the stage for their business and their practices and take most of the responsibility for future success. But it is critically important for small business owners to employ long-term thinking and actively manage their succession planning. Quite often, the quick pace of day-to-day operations and getting the business to succeed is the focus for owners. Planning for succession of ownership is relegated to a low-priority task, if it’s even considered at all in the early days.

Financial advisors can play an important role in helping small business owners think through the game from start to finish and plan accordingly. That means helping them develop and execute the right business structure for the early innings of the business. And helping them think through succession planning and what the future holds for the business to continue to thrive in future generations. And finally, their own financial future after they hang up their pitchers’ glove and spend more time in retirement doing the things they love – maybe even taking in a few more baseball games.

Early Innings: The Right Business Structure

Whether owners are just getting started in developing their own business or building their own medical practices, proper entity planning can be one of the most-important decisions. Proprietorship, partnership, S corporation, limited liability company, C corporation – each business form offers advantages and disadvantages. Determining the right business structure regulates how they will be taxed, their personal liability, how they acquire capital and ultimately valuate their business. As a financial advisor, you can serve as their coach and help lay out the options and bring the right consultants and subject matter experts to the table to help small business owners decide which is the best path for success.

No “I” in “Team”: A Plan for Developing a Successor
One of the first lessons you learn in sports is that there is no “I” in “team.” No one can do it alone in the small business arena either. Small business clients need a team and a support system in place for a business to be successful. Who is best able to run the business in the owners’ absence? Who can carry on the legacy of service and support for valued clients or patients in the practice? Preparing the next generation of managers is essential to sustaining long-term success of the firm. Two common options business owners often choose from in succession planning are to promote from within and look to existing management to lead, or to look to family as the next generation leadership.

There are benefits and drawbacks to each option. Current management likely shares a vision for the success of the business or has the same client-first philosophy and approach to managing the operations. Their experience in daily business activities and relationships with clients could be most valuable as well.

Or perhaps the owners have children who have spent years growing up in the firm and are capable managers in their own right. It’s a common and logical solution—and one that most entrepreneurs may want to choose. By doing so, they may seemingly help preserve the integrity of their business and provide financial security for their family but, despite its emotional and intuitive appeal, the odds are stacked squarely against a business surviving a transfer down the bloodline. According to the U.S. Small Business Administration, two-thirds of family-run enterprises fail to make the successful transition to a second generation of ownership, and fewer than 15% survive into the third generation. Making a successful transition even trickier are issues brought on by divorce, blended families, or rivalries among children.

For example, if they are transferring the firm to their children, a professional appraisal is generally required to withstand IRS scrutiny

Whichever approach they may choose, it is important to know the risks associated. Prudent business owners should address their business succession plans long before they are needed. The best course of action may be either to identify strong candidates within their company who can continue to run the business and provide a source of financial security for their family, or to look at the potential for selling the business to an outside party.

The needs of each business owner differ greatly when succession planning. Knowing what options are available can help determine which is right.

Don’t Strike Out: Properly Value the Business
It is important to know the value of a small business and what’s at stake in the succession planning process. Done the right way, a business owner gets the price they want and reduces the impact of capital gains and estate taxes. Done the wrong way and they might end up with a hefty capital gains tax bill and estate planning headaches. A financial professional, with the assistance of a qualified appraiser, can make the difference. As a financial advisor, you play a role in helping owners bring the right experts together to determine a financial value for their business in the event a sale is the best option. And you provide the expertise needed to steer your clients through a complex and time-consuming process.

There is no one-size-fits-all valuation for a small business. There are several valuation methods and many ways to structure a transaction. The right legal, financial and tax consultants can inform owners of the benefits and risks associated with any transaction. For example, if they are transferring the firm to their children, a professional appraisal is generally required to withstand IRS scrutiny. Small business owners can increase chances of a successful sale with coordinated efforts and working closely with a financial professional from the start if they are thinking about selling as an option for their business.

Prepare for Rain Delay: Have A Buy-Sell Agreement
Sometimes in business it’s best to prepare for the unexpected. Depending on the business and ownership structure, a buy-sell agreement can be an option for an ownership transfer between owners and their children, a non-family successor, or their partners. In other words, if an owner cannot operate his/her business before transitioning to a new owner, this document will determine how new ownership is assumed.

In addition to naming the responsible parties, whomever the new owner will be, this document also mandates how funds are appropriated in the owner’s absence. Proceeds from a life insurance policy are frequently used as a way to fund a buy-sell arrangement. Other options include loans from banks or company earnings that are paid back through an ‘earn-out’ arrangement with a successor, whereby the loan is paid back in regular installments.

The Final Inning: Don’t Forget Retirement
The majority of focus on succession planning is what will happen to the business after the owner retires. While it’s important to plan for the next chapter of the business, don’t forget about the retirement plans for the owner and their family. Have they saved up enough to retire in the lifestyle they are accustomed to? Do they have the right mix of products and solutions to continue earning income well into their retirement?

A comprehensive financial plan from the start will ensure that small business owners can retire the way they want and have a successful financial future even after exiting the business or handing over the reins.

Embarking on the business succession planning process is not something owners can take lightly. In the same way that each baseball team begins the season with preparation, planning and training for a successful season, business owners, including medical professionals and physicians, need to have a manager to help them develop a long-term view for achieving success for their business or their practices. Being an active manager in your client’s business activities and succession planning process can help ensure their exit strategy and retirement is a home run. ◊