A senior figure at Bank of the West Wealth Management talks about some of the thorny issues facing business owners when it comes to succession planning and transitions.

With a growing number of businesses in the US being privately-held, and many owners edging closer to retirement, the lines between succession planning, retirement planning and family wealth have blurred somewhat, Bank of the West said in a recent paper.

Citing data from the Small Business Administration, it noted that half of small business owners are over the age of 50 and that sales of Baby Boomer-owned small businesses are projected to reach new heights by the end of the decade.

The paper – Smooth Transitions: Three Steps for Wholesaler Succession – is, as its title suggests, written with an eye toward wholesalers, but its insights are applicable in a range of related contexts, the firm said.

There are many factors at play when it comes to thinking about and planning for business transitions. As Bank of the West points out, the process requires a willingness to address and answer difficult questions. Some of these are technical – in accounting, law, estate planning and business modeling. Others, meanwhile, are “deeply personal,” and shaped by family dynamics, family values, career goals and legacy.

“Supporting the emotional side of client decision-making is one of the most important and challenging areas,” the report's author, Kristin Nelson, told Family Wealth Report. But it’s the one area that “most paralyzes people into doing nothing,” Nelson, who is head of private business owner solutions at Bank of the West Wealth Management, said.

(Bank of the West Wealth Management launched its Private Business Owner Solutions offering in December last year. It aims to provide a coordinated and team-based approach for business owners as they manage their personal and business affairs - see more here.)

While trust and estate attorneys, CPAs and wealth managers may be equipped to help business owners through succession planning, “it’s important to find someone who has experience with succession planning, versus something they only address occasionally,” according to Nelson. “Additionally, they should also support a team approach as every advisor adds different value and can execute parts of the process.”

In her paper, she outlined three critical steps that business owners should take to facilitate a smooth and effective transition, whatever their ultimate goal may be.

First of all (as is the case for many other family wealth-related issues) it is crucial that businesses talk openly and realistically about succession in order to establish whether passing the baton to the next generation is a viable option – even if transitioning to a family member can carry significant trust and estate advantages.

The next step is to think about all the various options available, of which there are three, broadly: transfer the business to family members, sell it to people within the organization or sell to an outside third-party. Paramount here is to allow enough time for due diligence and preparation - to view the succession as a process, not an event (the report said the minimum amount of time it will generally take to find a buyer, sell and exit the business is about 18 months.)

The third step involves determining what the business is worth. Interestingly, only 38 per cent of RIAs recently polled by Fidelity said they have a strong grasp of how to augment the value of their firm, an issue compounded by the fact that many are simply not making this a priority. While the study focused on the RIA sector, many of its points are relevant to other business types (see the article here.) Nelson's report notes that the questions owners need to think about include: how steady sales and profits have been over the past five years; whether long-term relationships will remain when they retire; whether the business has transferable assets such as technology and real estate; and how deep its talent bench is.

Asked about some of the challenges associated with younger owners compared to Baby Boomers – who are often the main focus in this type of discussion – she emphasized that it is important to define “younger” in this context.

“For example, a business owner in their twenties who has started a technology company with the intention of selling it quickly is a different profile from a business owner who is their forties with teenagers and who plans on running the company for another 25+ years,” Nelson said. “The main thing I would point out is that there is a need for all business owners, no matter the age, to have a back-up plan. This is a little different than a succession plan, but the two are interrelated.”

She added: “If an unforeseen event happens to the owner tomorrow (resulting in serious illness, disability or death), what happens to the company? There are specific planning strategies for back-up plans, and there can be a big price if one isn’t in place. Take for example, a successful surgeon who has his own practice. That practice is worth a lot to the family, but if there is no back-up plan, and something unforeseen happens, it could be worth nothing the next day. That is why it is so important to make a plan.”

A verbal arrangement isn't enough; a formal plan is essential, Nelson warned.

“Every business owner should have an emergency back-up plan and an ultimate succession plan,” she said. “For example, if a business is owned by two partners, they may have a back-up plan if something happens to one of them. A common strategy is a formal buy-sell agreement. If something happens to one of them, the other one buys the other half of the business. Sometimes this is funded through life insurance. But then, ultimately, let’s say that both owners want their employees to own the business...as a longer term succession plan, they have an ESOP (Employee Stock Ownership Plan) in place.

“This is just one of many examples, but business owners need to understand that a back-up plan needs to be in writing, and needs to be consistent with their trust and estate planning.”