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A couple of months ago I wrote a post called “Where’s the Exit?” That post talked about the importance of an exit strategy to a small business owner. I can’t stress enough that your retirement exit strategy should be in place as early as possible. Plenty of things can happen in life that might cause you to implement it earlier than intended. If that happens, you don’t want to be caught flat footed.

Author’s Note: throughout this post “he”, “him” and “his” refer to both genders and are used only as a convenience because I hate typing he/her, his/her, etc. It’s tedious.

Today I’m going to talk about a common exit strategy for small business owners – passing the business to a family member. Thought this is a fairly common practice, it’s also pretty common for a business to go into a decline or even fail after the second or third generation takes over from the company founder. There is something to know about how to manage this process.

This article addresses the management concerns only it does not address legal, financial or tax issues of business succession.

Stages of Business

A business owner will go through two major stages in business. There isn’t a hard dividing line between the first and the second. The business progresses from the first to the second on a gradient, gradually moving from one to two as the business grows.

In stage one he does the work himself. He’s answering phones, servicing customers, marketing, selling, etc. Everything that needs doing is done by the business owner. As business grows, he begins to bring on staff to handle various functions of the business. He trains his new staff members ensuring they are performing their duties in the manner he wants them performed. He issues policies, he does on-the-job training of his personnel. He sees to it that his employees are competent and have the tools they need to succeed at their jobs.

While in stage one, he writes up and gets policies known. He streamlines operations and puts systems in place for handling the various types of traffic the company will have to handle and further trains the staff on those systems. He gets every aspect of the business documented. He ensures that everything he knows about his industry and his particular business are written up and passed on to the people in his company who will now need this information to be able to do their jobs.

Eventually he has a team that is performing all of the functions necessary for the business to be viable, he has procedures laid out in policy and followed by the staff, his processes for creating his products or delivering his services are solidly in place as systems so that customers get the same experience every time. When he has all of this in place and he no longer has to jump in and handle this, that or the other thing, he and his business have arrived at the second stage. In this stage, his job is to see that others get the work done. His job as this stage would also include refining and improving the business organization and systems to make them better.

Handing the Business Down to a Family Member Upon Retirement

If he wants to hand the business down to a family member such as a son, daughter, niece or nephew, He’ll have to go through all of the above if he wants his heirs to be successful.

If he has more than one family member who will inherit the business from him, he’s got some decisions to make. There can only be one person in charge of day to day operations. One family member needs to be named as “Chairman/CEO” or whatever title they’re going to have. The title doesn’t matter much. What matters is that everyone knows that this family member is where the proverbial buck stops. The other family members who want to work in the business would be given appropriate jobs within the organization, whether they own shares in the business or not, their roles would be defined by the positions they hold.

Determining the Roles of Heirs

If the retirement plan for the business’ founder is to turn the company over to an heir, the process of grooming the heir to eventually run things should start as early as possible. When there are multiple heirs, they should all start working in the business as early as possible. The heirs should work in every single area of the company over time so they know how everything works. During this process the Founder must observe the heirs, their production and their leadership skills. The one who is most productive and the best leader should be named to be in charge. Other heirs would stay on in the roles that make most sense based on their skills and abilities.

Shares Don’t Equate to Managing

This statement is obvious if you look at it in the context of a large publicly traded company. I might own shares of General Electric or 3M, but those shares don’t entitle me to take an active role as a company executive. They entitle me to a vote (usually one per share) at shareholder meetings. They entitle me to a dividend check of the company pays dividends.

A privately held company should be similarly set up when there are multiple heirs. The ownership shares they inherit should entitle them to the same rights they’d have if they bought shares in a public corporation. This should all be clearly stated by the Founder in policy and in any legal documents that transfer shares from him to his heirs either on retirement or at his death.

When is Your Heir Ready to Take Over?

How do you know when the successor you’ve named is ready to manage the business? Your heir would be best positioned for success if you’ve done all of the actions laid out above and gotten your business stably into the second stage. A good question the founder can ask himself is, “Can I leave my successor in charge while I take an extended vacation and return to find the business in good shape?” If the answer to that question is yes, the heir is ready to take over. If you’re unsure, it might be wise to give it a test and take a vacation and see what happens.

Pitfalls

The following things can trip up a business owner whose exit strategy is to pass the business on to a family member:

  1. Not being thorough when writing up everything he knows about the business and how it runs. An analogy would be passing on a cookie recipe that left out an ingredient or didn’t thoroughly cover some special technique for making the cookies. Anyone receiving that recipe would likely come out with cookies that were still pretty good, but not as good as the originals.
  2. Failing to set up a reliable system for training new employees as they are taken on. This is often overlooked. Without a functioning training system, employees who are taken on after the founder leaves will not be as well trained as those the founder trained personally. A well designed training system ensures all incoming personnel will be as well trained as those personally trained by company’s founder.
  3. The most thorough and well set up policies, systems and training procedures can all be wasted very quickly if the heir decides to put his “stamp” on the business by making huge changes after the founder leaves. This is a huge mistake. As the saying goes, “If it ain’t broke, don’t fix it.” When a business is running well, why would you change it? There are exact steps that must be taken to determine whether or not an intended change will work and be beneficial or not. Only when you’ve taken those steps would you integrate that change into the organization.
  4. Not apprenticing the heir as the manager of the business and turning over the founder’s connections to the new head of the business. Long time vendors, staff and customers may tend to unfavorably compare the heir to the founder when this isn’t done. The apprenticing step allows the heir to gain the respect of all concerned while the founder is still there.

Who Should Be Part of the Team

Implementing your exit strategy takes a team. There are a number of things that have to be considered and expertly handled for a business succession to be successful across the board. The team should consist of:

  • An attorney to handle the legal aspects of transferring ownership or control from the founder to the heir.
  • A tax expert/accountant to help minimize the tax impact of the ownership change.
  • A financial planner should be involved early to help the founder financially prepare for retirement with a retirement plan that meets his financial needs in retirement.
  • A management consultant to help navigate the operational aspects of making the transition and who can help ensure that the heir is fully capable of taking the business over and continuing to expand it from there.

In future posts I’ll address steps you can take to position your business to get the best possible sale price and what you should consider when shutting your business down.

Schedule a free consultation about your exit strategy today!