You know them when you meet them. Sometimes all it takes is a handshake. The kind who hold company retreats at their lake house, and when asked how long they have been in the game, they tell you they invented the game. These entrepreneurs see their company as an extension of their personhood. It is not only a hobby or profession, but a lifestyle. And giving it up—that is the hard part.
These intrepid business owners are usually the type who turn a blind eye to a buyout from an outside party with deep pockets. Instead, they often take the long—and sometimes hard—road when transitioning ownership of their business. Are you one them?
If you own a business, you probably fall into one of three camps concerning ownership transition:
You want to maintain current involvement and ownership
You want to maintain ownership, but reduce involvement in your business over time
You want to change or reduce ownership in your business
Even if you are not in the third camp yet, you might be in the future.
You need a living transition plan
Giving up or reducing ownership requires a living transition plan, which addresses the transition of the business to its next owner. This may or may not include a succession plan, depending on the type of transition desired. Creating a living transition plan requires coordination of an intimidating matrix of personal, financial, family, tax and legal issues, and it is commonly done in phases.
When do you start? At least two or three years before you are planning to exit or relieve yourself of major duties.
Creating a living transition plan is one part retirement planning and one part risk management. As an entrepreneur, you have a lot of risk. When you were younger and did not have as much to lose, you were probably willing to take greater risks. But now that you are successful and have developed a certain lifestyle, you are beginning to realize what’s at stake.
Remind yourself it is a transition versus a transaction. Instead of seeking outside investors, your goal is to set your employees up for success and safeguard the heart and soul of your business. A living transition plan should enhance the overall business model, continuously positioning the company for long-term growth and sustainability. Keep in mind that to further support the longevity of the business, you cannot over leverage it. To do this, you must transition the company to a generation that is more innovative, relevant, and in touch with your day-to-day customers.
Thus, you need great managers and less personal limelight. Your company must have some wherewithal and the makings of a true management team. Without strong finance and administration personnel, strong operations, oversight and business development, a living transition won’t work. Most importantly, key components of the business can’t be centered around you, the owner.
The 5-step process
You will craft a plan and then structure how you communicate the transition—first with family and then with business executives.
1. The plan. One of the most difficult aspects of business transition planning is addressing the emotional issues generated by significant change. You do not want employees to plan a mutiny, just as much as you do not want your children to feel like they have lost their inheritance.
Business owners should ask themselves:
How do I want the business transition to impact my lifestyle?
Do I want to give up control of my business?
If so, how much control, when and to whom?
What do I need financially from the business to meet my long-term objectives?
How will my family, other shareholders and/or my employees be affected by my departure?
If you are seriously considering a living transition plan, you have already answered some of these questions. The next phase is making it public. You must know your audience before you discuss transition plans with them. Knowing your audience will help you craft the right message, and help change people’s perceptions and support.
After every meeting—family or other—document and provide notes. Detailed note taking will help eliminate emotional responses and confusion. This is also where a trusted adviser will become an important part of every meeting.
2. Communicate to family. First, communicate with family members as soon as possible. Keep in mind this is a business conversation, not a family conversation. Be prepared for family members to get scared, ask what you are going to do with all your free time and ask how much you are getting for the business. Remind them it is a transition not a transaction.
This is where a trusted financial adviser and/or senior level company executive is worth their weight in gold. An adviser can help you create thoughtful messaging and serve as a formal mediator between all parties involved—even family. Remember, this adviser must also document all formal meeting notes.
You will need to consider the following family questions:
How do I treat all family members equitably?
Do I want to gift all or part of the business to my family?
Do I want to sell the business to certain family members?
3. Communicate with executives. Next, have a closed-door conversation with upper level management to discuss their long-term objectives and career pathing goals. This conversation should let you know if the team has any interest in purchasing part of the company.
You will need to consider the following key employee questions:
Can the business support the transition?
Can I afford the risk of an internal buyout?
How can employees finance a down payment and become party to the next generation?
4. Loop in employees. Communicate with the rest of your employees after you have designed the first phase of the living transition. Focus the messaging on long-term objectives versus the price point.
5. Query outside parties. Depending on the details of the transition, you may need to consider the following questions for a business consultant:
What is the best structure?
Should I integrate the sale into an estate plan?
How can I maximize my tax results?
Throughout this 5-step process, there are various approach scenarios. These two are the most common:
Transition scenario 1: Dipping your toes in the water.
It is healthy to dip your toes in the water in a responsible and fair way, letting all parties know there are no further commitments during this phase of the transition. In this scenario, your senior management team could buy 9% of the company through an arm’s length transaction.
From there, you could create a gifting plan which would give nine percent of the company to your children. Next, you could professionalize the company by selling 30% to an employee stock ownership plan (ESOP). An ESOP offers significant tax advantages, but also allows you to take some of the chips off the table so to speak, while still maintaining control of the company. Now test out the waters.
Does this set-up feel right for your goals and lifestyle?
Are you comfortable giving up this much control of your business?
Are you willing to give up more?
If you are willing to give up more and move into the second phase of the transition, you can sell the rest of the business to an outside party, make the ESOP larger, give more to your children or have management buy a larger portion of the company. Before you finalize a plan that gives away your complete control of the business, make sure all parties involved are prepared to handle operations. Once the living transition plan is designed, a contingency plan consistent with the objectives of the transition plan should be developed.
Transition scenario 2: Work on the business, not in the business.
If your management team is not ready to take over the company, consider re-organizing the business structure, focusing on compensation and incentives—not the transaction of ownership. This allows you to transition out of the business over time.
In this scenario, two partners may want to sell to an outside party, but they need to get employee support. It is important to communicate to employees that you do not want to sell the business out from underneath them, but instead create a transition that is mutually beneficial to everyone.
You will need to create a structure to help advance the management team and reward them for their efforts while addressing compensation, bonuses and long-term incentives. Once reorganized, you will have complete confidence that the business can run successfully without you being embedded in it. When removed from daily operations, you can work on the business, but not in the business. Once the living transition plan is designed, a contingency plan should be developed consistent with the objectives of the transition plan.
Whatever plan you choose—or even if you decide to hold onto the reins a little longer—a trusted financial adviser, business consultant and/or senior level company executive is worth their weight in gold. Once you have stepped out of the game entirely, you can tell people you are reinventing the retirement game.
Copyright © 2016 Entrepreneur Media, Inc. All rights reserved.
This article originally appeared on Entrepreneur.com. Minor edits have been done by the Entrepreneur.com.ph editors.
Photos from Thinkstock