Small business succession planning: establishing a legacy

Small business succession planning is more than just selling your business when you retire. It’s about creating an exit strategy that takes into account your community, your employees, and the emotional and detailed process that is selling a business. It’s about establishing a legacy.
small business succession planning by owners with team members

Small businesses are an integral part of American life and its economy. There are an estimated 33.2 million small businesses in the U.S., employing 61.7 million people—nearly half of America’s workforce.

Today, however, our country faces a small business succession problem. Each year, more than 200,000 small businesses are listed for sale, but only about 30% of those businesses ever find a buyer. And without a buyer or a clear plan in place for when an owner decides to retire, small businesses often fail. This compounds when you factor in the current economic uncertainty.

Succession planning is crucial for small businesses because it helps owners and employees strategically prepare for what happens when a business owner retires and moves on from the company.

We spoke with Lauren Altschuler, CEPA, CBI, M&A Advisor at Transitions in Business, for her insight on small business succession planning.

With over 30 years of experience in sales, marketing, and management for retail and media companies, one of Lauren’s key focus points is bringing together buyers and sellers of privately held businesses for a sale. Her goal is to help clients increase the value of their biggest asset, their business, and ensure they have the right transition team in place when preparing for a sale.

At Teamshares, our goal is to help a network of 10,000 small businesses become employee-owned while supporting a generation of business owners through confident retirement.

We’ve worked with Lauren on small business acquisitions, and we’re excited to share her insights on the value of small business succession planning, strategies for small business owners, how to create a small business succession plan, and other tips.

What is business succession planning?

Succession planning is a business strategy for passing the leadership role of a company from the current owner to another person. Succession planning typically happens when owners are preparing to retire and need to hand off the reins to a “successor.”

Succession planning is not just a high-level strategy. It’s an in-depth process of preparing and training employees, documenting business processes, compiling financial statements, building an exit timeline, and much more.

Having a small business succession plan in place is critical to ensure processes run smoothly and the transition causes minimal interruption to business operations.

Small business succession planning can be even more important in the case of an unexpected transition caused by the death, illness, or disability of the business owner.

In a worst-case scenario, without a good small business succession plan in place, the family or heirs of a business owner may be forced to sell the company under duress, for less money than it’s worth and with no clear plan for what happens next for the company or its employees.

When to start a small business succession plan

Every business is different, so there’s no single right time or one-size-fits-all answer for when to start succession planning. But there are some general guidelines. “Ideally, a small business owner should begin succession planning at least three to five years before they want to sell their business,” Lauren explains.

Planning three to five years in advance gives business owners the flexibility to make careful and calculated decisions in preparation for a sale.

“On average, it takes a year to sell a business,” Lauren says. “Although some businesses take less time or more time, depending on how many challenges a sale poses to a buyer.”

Selling a business can be a very emotional process, and planning so far in advance gives owners time to work through their emotions and make good decisions for the business and sale.

Lauren encourages owners to have a “post-sale” plan in mind, to help ensure that their emotions don’t hinder a potential sale.

Small business succession planning strategies

Small business owners are experts at running their businesses. But, in many cases, they’re not experts in selling them. This is where brokers come into play.

Brokers can help small business owners avoid common pitfalls, introduce the seller to a larger pool of buyers, offer a wealth of industry knowledge, and act as a buffer between the owner and buyer.

Because selling a business is a very emotional process for owners and employees, a looming sale could cause significant shifts within a company’s dynamics and culture.

Small business succession planning allows business owners to fully consider the impact that selling a business will have on its employees and what the sale will mean for their future.

1. Selling a small business to an outside party

Selling a small business to a third party is a time-consuming process, and many small business owners simply don’t have the bandwidth to do it on their own while running the business.

A third party sale poses significant challenges to small business owners. Marketing the business to potential buyers, navigating due diligence, negotiating a transaction, the complexity of completing legal documentation, and providing the necessary tax documentation, are all difficult for a small business owner to navigate alone.

Even after the sale, small business owners often struggle with transitioning the business to its new ownership. To help mitigate this stress and uncertainty for former owners and employees, Teamshares has a clear, consistent, and proven process for transitioning companies to employee ownership with the goal of the business never selling again.

Are you a broker or business owner that needs an exit plan to keep your company and employees in place?

Ultimately, we believe that the most local and invested buyer—current employees—is the right one. Through the Teamshares model, employees eventually own 80% of the small business they’ve dedicated their time to. This leads to a better outcomes for the business and long-term wealth for employees.

At Teamshares, we look for small businesses to meet a specific set of criteria across geography, industry, real estate, earnings, and number of owners. These strict criteria allow us to close on 90% of the businesses on which we submit Letters of Intent (LOI)’s. The criteria are:

  • Geography: Only U.S.-based businesses
  • Retirement sale: The owner is of true retirement age, 50 or older
  • Steady owner earnings: Generally, Seller Discretionary Earnings (SDE), EBITDA plus owner compensation, of $400K to $2M in two of the last three years, tax return provable. We consider restaurant SDEs as low as $250K
  • Ownership: We prefer to work with only one or two retiring owners
  • Real estate: Both multi-year leases and real estate purchases on a case-by-case basis

2. Family business succession planning

Family succession planning is when the business stays within the family—typically going to an heir or someone in the next generation. However, statistically, many small businesses don’t stay within a family for generations.

According to the U.S. Small Business Administration (SBA), only 30% of family-owned businesses survive into the second generation, 12% into the third, and 3% into the fourth and beyond. Given this, it’s wise for owners to consider alternative succession planning strategies.

3. Selling the business to an employee

Directly selling a business to an employee may seem like a logical next step for some business owners, but there are significant barriers to entry. For an employee to purchase a business outright, the cost is often the biggest hurdle.

Many employees may not have access to the finances or the credit needed to make a large-scale purchase, especially in today’s lending landscape. This means that either an owner can’t successfully make the sale to an employee happen or they would have to accept a lower price than they hoped for.

In these instances, selling to a third party who shares the same vision for the business’s success and who has the liquidity to purchase the company may be a better option.

4. Liquidating the business

Liquidation is when an owner sells off the company’s assets. While commonly associated with insolvent businesses that need to pay off creditors and shareholders, this can also be a last resort option for owners who can’t find a buyer.

However, liquidating a business has negative impacts because it leaves employees without a job and a community without a small business.

How to create a succession plan

There is no one-size-fits-all succession planning process. Each plan should be specific to the business and determined by the needs of its employees, management, and operations.

But, according to Lauren, there are some baseline things that all buyers are looking for:

  • Steady increase in profits and revenue for three straight years
  • Established customer base
  • Low customer concentration
  • Residual income stream
  • Good, established reputation
  • Documented processes and procedures
  • Positive cash flow
  • Minimal reliance on the owner to train new leader
  • Growth market segment
  • Employee longevity and skills

If your business shares these qualities and you are ready to begin small business succession planning, the first step is building a timeline for when you plan to exit the company.

Build a timeline for exiting the business

For most owners, setting a timeline means deciding when it makes the most sense for them to retire.

“The best time to sell a business is when an owner least wants to. In other words, owners should sell their business when it’s running like a well-oiled engine, humming along without much effort. This is when the business will be most attractive to buyers,” Lauren says.

She also recommends that owners engage a broker to help with the process and to ask them the right questions to find a good match. Lauren suggests asking potential brokers the following questions:

  • Do you co-broker?
  • Do you charge anything upfront?
  • What is your process?
  • What is your average time on the market for a sale?
  • Of the businesses you’ve listed, how many have sold?
  • Do you have any testimonials?
  • How many businesses with similar EBITDA have you sold?

Owners should talk to at least three brokers to get different points of view.

“Find at least one broker who is local, so you can meet with them in person. Additionally, it’s important to get referrals from your Advisor Team (CPAs, attorneys, financial advisors, etc.),” Lauren explains.

Determine the value of the business

Once you have a timeline and a broker, the next step is to determine the value of your small business. This is one area where brokers can help.

“As your business broker, the first thing in our strategy is to analyze your operations, finances, market potential, and industry trends,” says Lauren.

“We take that information and advise you on steps to prepare your business for sale, and generate a business profile that represents your company in the most attractive way possible.”

Lauren suggests talking to an M&A advisor who understands the current market climate and regularly works with both buyers and sellers. This ensures they have a holistic view of the market, and can help you assess the value of the business and any associated property or capital equipment.

“M&A advisors have a pretty good idea about how much buyers would be willing to pay for a business based on a set of evaluation criteria. These typically include multiples of cash flow to cover debt, their salary, and a decent return on their investment,” Lauren continues.

“The numbers have to make sense, or buyers will walk away,” Lauren says. ”So it’s important for owners to have a good grasp of the market value of their business. It serves as a benchmark for improvement and helps you decide if it’s the right time to go to market.”

Lastly, Lauren emphasizes the importance of maximizing your seller discretionary earnings (SDE). Your seller’s discretionary earnings are a measure of your financial performance in the lead-up to the sale. Sellers should be strategic about when the business is put on the market to show the highest earnings possible.

When timed right, every dollar of SDE could net $2 to $3.50 more in selling price. If you grow your sales by just $30,000 in this period, your business could reap an extra $100,000 in sale price. Because growing businesses sell for a premium, every effort should be made to show financial growth during this time period.

Compile financial statements

Putting your financial affairs in order is a crucial aspect of business succession planning. “If you don’t already have them, hire a bookkeeper, controller, or fractional CFO consultant to help you clean up the balance sheet, generate a profit and loss statement, and remove personal expenses from the income statement,” Lauren suggests.

According to Lauren, “most buyers will want to look at the last three to five years of a company’s cash flow.

This is also the perfect time to have a CPA conduct an audit of your business.

“During an audit, a CPA will review your company’s management and provide independent verification of your financial information,” Lauren says. “Doing so signals due diligence to prospective buyers and shows that they can trust the thoroughness and accuracy of your company’s financial statements.”

Document processes and operations

When you sell your business to an outside party, the buyers aren’t initially going to be up to speed with the key operations and processes. This can create bottlenecks for your team when a successor takes over.

For this reason, it’s important to compile a number of documents to ease the transition, including:

  • A list of things the owner does for day-to-day operations. These should be broken up into essential versus non-essential tasks.
  • A list of key employees and positions along with their duties and responsibilities.
  • A list of all assets and facilities.
  • A compilation of related documents, employee handbooks, and training documentation.

Next, you’ll want to consider who will be your successor.

Choose a successor

Choosing a successor is probably the most important decision in small business succession planning. Ultimately, this transition affects the company’s future, its viability, and the state of the workplace for employees.

Typically, owners have a number of different options to choose from: a family member, a business partner, an employee, or a third-party successor.

At Teamshares, we believe in hiring generalist leaders to accelerate the growth and to complement what was previously successful at the business.

Announce the succession plan

Selling a small business is a delicate matter. Honesty and transparency are important for the customers and community, but especially for employees who’ve dedicated so much time to the business.

There are a few approaches to take when it comes to announcing the sale of a business: telling everyone when you list your business, after an LOI has been submitted, or immediately after the sale. Telling employees upfront, even in small numbers, tends to be risky for several reasons:

  • Not being able to answer questions about who the buyer will be
  • Not being able to answer questions about when the business will be sold
  • Not knowing what changes will be made

Regardless of when you choose to announce the sale of your business, it’s important to consider how the news will be delivered, as this can be very emotional for both employees and the owner.

If possible, we recommend telling key employees about the decision first. This can be a good opportunity to take leaders or managers to lunch or coffee and let them know why you’re selling the business. At these meetings, it’s important to show appreciation and reassure employees that they still have a job.

It’s also important to stress how the small business succession plan will be gradual and explain how it will help preserve the legacy of the business and guarantee its continued success.

If you’re selling a business to Teamshares, this is a great opportunity to explain the value of employee ownership and how, as the current owner, you will remain in the business for 45 days after the sale.

Succession planning tips from a small business broker

As a small business broker, Lauren suggests a number of succession planning tips that owners should employ:

  • Prepare for a sale by building out your team of advisors.
  • Solidify a relationship with a financial advisor, an M&A attorney, a business broker or M&A advisor, and a CPA.
  • Get a broker’s opinion about the business’s value and share it with a lender to find out if they would finance it. If not, be sure to have them explain why.
  • Make sure your financial processes and records are in order.
  • Get a list of due diligence items from your broker ahead of time so you can start to compile the documents you’ll need for a potential buyer. These take time, so it’s better to start early.

“Ultimately, the more prepared you are for your business sale, the smoother the process will be. The better prepared your exit strategy is, the more likely it will sell and the higher the selling price it will command,” says Lauren. “Even a few minor enhancements can dramatically increase the marketability of your business.”

Selling a small business is an incredibly emotional decision for both the owner and its employees. It’s essential to start planning early on, to have the time to work through those emotions and make good decisions for the business.

At Teamshares, we understand how important your small business is to you, and are focused on preserving your legacy while providing a win-win situation for the employees who have worked so hard to help build the business. If you’re a broker or a selling owner, find out if Teamshares is the right buyer for your small business.

Teamshares writers follow strict principles for sourcing credible information within articles. Any outside information including direct quotes, paraphrased information, and concepts that are derived from external sources adhere to our standards for accuracy and transparency.

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