I often hear business owners referring to succession planning and exit planning as though they’re interchangeable terms. While similar, the differences between a sale, a succession, and an exit are significant. Each one has a different end goal in mind. Understanding the differences and how they work together is critical. That’s why today’s entry is all about succession planning vs. exit planning and how to use each.
Follow Along With The Financially Simple Podcast!
This week on The Financially Simple Podcast:
- (1:00) What is Succession Planning?
- (2:01) The Many Benefits
- (5:36) When Should You Begin Succession Planning
- (7:48) Introduction to Exit Planning
- (9:26) How Exit Planning Benefits Owner and Business
- (10:41) Facilitating a Sale Without Making an Exit
Succession Planning Vs. Exit Planning: What’s the Difference?
Despite their overlapping nature, succession planning and exit planning aren’t interchangeable. They each offer great benefits to your business but thinking a succession plan will suffice when you need an exit plan (or vice versa) is a bit like grabbing a Phillips head screwdriver to turn a flathead screw. But what is the difference between the two? When is it appropriate to use one over the other? Let’s take a closer look at succession planning vs. exit planning.
The Society for Human Resource Management (SHRM) describes succession planning as, “a focused process for keeping talent in the pipeline.” They go on to say that it “is generally a 12- to 36-month process of preparation, not pre-selection.”But what does that mean? Put simply, it means you must identify the skills, practices, and knowledge necessary for business continuity once you’re no longer occupying your current role.
In fact, it may be helpful to think of succession planning as a type of contingency plan (i.e. when X occurs, Y goes into effect). Essentially, you’re creating a contingency plan so your business can continue if you sell, retire, or pass away. In doing so, you may reap many benefits.
For starters, succession planning increases the availability of qualified individuals prepared to assume leadership roles as they open. Unlike reactive hiring practices, the succession planning process is well-planned-out. It is a long-term procedure of building several internal pools of qualified candidates who are able to fill vacancies. This can also mitigate the risk of losing key employees that might otherwise seek advancement opportunities outside of your business. However, these aren’t the only benefits.
The Benefits of Having a Succession Plan
Creating a well-thought-out succession plan enables you to identify the individual or individuals who will take control of the business in your absence. Knowing who will take over your business allows you to tailor the organization to their unique skills and abilities. Think of runners in a relay race. Each one takes the baton from the previous runner to complete the goal. Once you know the strengths of each runner, you can put them in the positions they’re most likely to succeed.
Similarly, you can use the succession plan to build your company in a way that allows you to master your own strengths. This could enable you to leverage these strengths upon your exit, either with the buyer or in your next business venture. In fact, that’s exactly what I did in my own company. I developed a succession plan to prepare for an eventual sale or exit. Then, when I sold my business, I could use my enhanced skill set in a new way under the new owners. A good succession plan can actually provide you with a lot of freedom in that way. You could do as I did and continue working in the business after the sale, or you could make a clean exit to retire or pursue your next goal.
A good succession plan can help you move from a tax mitigation mode to a value acceleration mode. Oftentimes, small business owners try to operate in a very tax-efficient manner. Showing low profits is great when trying to keep your tax bill low. However, this strategy could backfire if you’re thinking of selling in the next few years. You see, prospective buyers will be paying close attention to historical financial reports. The lower the profits, the lower the potential offer.
When Should You Begin?
If you haven’t already begun working on a succession plan, start now. Even if you’re years away from making a sale or exit, the succession plan can be reviewed and modified on an annual basis, as you work through it. Don’t make the mistake of thinking you can wait until you’re ready to hand the business over to the next group of leaders.
Eido Walny, founder of the boutique estate planning law firm, Walny Legal Group, believes succession planning is overlooked far too often in small businesses.
“Statistics bear out that 60-70 percent of small business owners wish to pass along their businesses to the next generation of family members, yet only about 15 percent ever do that,” says Walny. “The key to understanding that massive disconnect is in the lack of business succession planning. Business succession can’t be founded on a wish. Handing over keys one morning is not a plan. There is a lot that needs to be thought through, and the facts bear out that very few business owners give enough thought to succession planning.”
Different from succession planning, exit planning is defined by Divestopedia as, “The complete strategy for exiting a privately held company. It involves analyzing the financial, legal and tax options and repercussions for leaving an organization.” Ultimately, the goal of exit planning is to maximize the saleable value of the company while ensuring that your personal and business goals are met and tax liabilities are kept to a minimum.
Although there is some overlap when looking at succession planning vs. exit planning, you’re working to achieve different outcomes. You see, where succession planning takes a hard focus on business continuity, exit planning takes a more holistic and comprehensive approach. Exit Planning addresses the owner’s desires, current and future planning (including value growth, personal finance, and tax planning), transition, employees, family, market positioning, and more. Each part of the exit plan takes your goals into account and maps out a path to reach them.
How Exit Planning Benefits Your Business
A good exit plan accounts for the business’s current value aligning it with your personal financial plan. Looking at your wealth gap, you can implement value growth strategies that will help you close the gap.
However, exit planning also allows you to address potential hazards that could complicate the successful transfer of your business either to family members, key employees, or third-party buyers. As your exit plan accounts for your succession plan, you can determine who is best suited to take over the company successfully, maintaining growth and keeping in alignment with the vision, mission, and values. If those you’ve identified to take control don’t have the necessary skills or qualifications to handle ownership, your exit plan could include steps to train and develop them. Conversely, it could also include alternate exit strategies to ensure the business is left in the best hands possible.
Beyond value growth and a successful transition, exit planning also offers many other benefits such as:
- Providing methods of protecting the value you’ve built.
- Preparing you for the emotional fallout of leaving your business.
- Making your business more attractive to buyers.
- Adding clarity to when you should sell.
How a Sale Fits Into the Mix
Regardless of which type of transfer you choose for your business, you’ll need to use succession planning. Now, I’m also a big fan of starting your business with the exit in mind. Therefore, exit planning is necessary and can’t be started too early. However, there’s another scenario at work here; one that I’ve lived out in my own business.
You see, I started my business with an exit in mind. I worked diligently with my team to maximize value, growth, and efficiency. I knew the business was one of my greatest assets and that I could leverage it to achieve my own goals while helping others reach theirs. Knowing that none of us are promised another moment and at the very least, I would eventually retire, I had to prepare a succession plan to ensure that the business could continue without me.
In the process, I made the ultimate sale. I found a buyer that met each of the criteria outlined in my succession plan. But I wasn’t ready to retire. That’s where the succession plan I had built to maximize my strengths really showed its value. I sold my business but I didn’t exit. Instead, the buyers recognized that my skills and talents could be useful in achieving their goals. With my sale, I saw a successful transfer, succession from my previous role, and many of the goals I set for my exit plan realized.
Now, if I decide that 5 years from now, I want to teach my boys how to start a business, I could make an exit at that point. In the meantime, I’ve still got goals for this enterprise. Understanding succession planning vs. exit planning — how they’re different and how they work together — was a vital piece of accomplishing those goals.
Friends, don’t wait until the last moment (or until it’s too late) to create your succession plan. Likewise, get moving on your exit plan. It takes time to work through these plans and the benefits of having them far outweigh any arguments to the contrary. I know owning a business is demanding. It’s hard. But putting in the extra effort to create these plans right now can create lasting benefits and even improve the value of your company.
Look, life is hard. None of us knows what the next moment will bring, but life is good. Creating succession and exit plans can be frustrating, but it doesn’t have to be. With a better understanding of when to use succession planning vs. exit planning, we can at least make things financially simple. Let’s go out and make it a great day!