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Grooming a Successor

Apr 1, 2008

There's a fatal flaw in the retirement plans of many small business owners. After pouring a lifetime of sweat, time and capital into building the business, their rough sketch exit strategy is to sell out for a lot of money, then settle back and enjoy a financially secure retirement.

Many business owners are so sure this will happen that they don't bother to make any other retirement plans. But who is this entity or person that, at just the right moment, will show up with cash in hand to buy the company and pay a fair price?

For thousands of small business owners each year, no one steps forward. Perhaps the business is too specialized or is tied too closely to the owner's unique personality and skills.

Or perhaps possible buyers equate retirement sale with distress sale and make only low ball offers. Whatever the reason, many owners find that their company has suddenly become a white elephant that nobody wants.

One possible solution is to groom your own replacement; someone who will buy your company when you're ready to retire. Maybe this person is a current co-owner. In that case, be careful if the individual is about the same age as you are and is counting on retiring at about the same time.

Other potential successors are a son or daughter active in the business, or a younger key employee. Business owners who successfully groom their own replacements leave nothing to chance. They realize that there is no room for error at the point of retirement. Here are some steps to take to groom a successor:

  • Make sure your heir apparent is the right person in terms of temperament, personality, competence and personal goals.
  • Set up a probation period so you can terminate the relationship if you find this person simply will not work out. During that period, keep everything informal, strictly verbal. At the same time, even when you go to a formal agreement, make sure it contains a termination provision.
  • Fashion golden handcuffs and incentives to ensure that your replacement stays until the baton is passed. An ambitious successor needs and deserves gradually increasing authority and benefits. Options include deferred compensation or the opportunity to acquire partial ownership prior to their retirement. Both parties need something to win by sticking to the agreement, and something to lose if it falls apart.
  • Put it in writing, along with the help of an attorney. Lock in who does and gets what, and spell out all details and caveats, including how to establish the final valuation of the business. This formal buy/sell agreement protects everybody.
  • Build in a funding mechanism. This is crucial. No matter how good the terms of the buy/sell agreement, it will be worthless if the money is not there when needed to carry out the plan. Under one option, the successor may be able to purchase the company from ongoing profits. Other options include setting up a sinking fund, or allowing the successor to simply borrow the money. These options may work but they leave much to chance. Instead, the recommended funding vehicle, one that protects your family in the event of your disability or premature death, is life and disability income insurance.
  • Have a backup plan. As a business owner, you know that very few things go exactly as planned. What if your business hits tough times or your successor dies, becomes disabled, or leaves because of a personality conflict. The latter happens all too often. Or what if there simply is no heir apparent waiting in the wings? Sometimes, it's simply best to dismantle the business.
Whether or not you have a possible successor for your company, you should begin mapping out your retirement strategy today.

Information in this article was edited from a story in The Daily Advertiser.

Topic: Business Strategies

Related Articles: small business 

Article ID: 561

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