The Small Business Owner’s Guide to Internal Succession Planning

Succession planning is a complicated subject, especially for small business owners. When will you sell? How much will you sell for? What’s your exit plan? 

Who will buy your business?

When it comes to that last question, potential buyers fall into two categories: 

1. External, meaning someone outside your business, such as private equity firms, a new external business owner, or a merger with another business, or 
2. Internal, such as your children, your partner, one or more of your key personnel, or another employee.

While it might sound easier to hand your company over to an internal buyer – they already know your business, right? – it’s actually much more complicated for several reasons. From finances to emotions to operations, internal succession planning (a.k.a., exit planning or perpetuation planning) can be extremely challenging – and rewarding.

Today, I want to walk through the ins and outs of small business internal succession planning, and how to set yourself up for a better chance of success.

The 6 Factors of Internal Succession Planning for Small Business Owners

1. Identify Your Personal Goals

Like I said in my last article, for most business owners, selling your business is what makes your retirement possible. According to the Exit Planning Institute, 80-90% of the average small business owner’s wealth is tied up in their business. In addition, 78% expect the sale of their business to fund at least 60% of their retirement.

That’s why we put your personal goals first before looking at anything else, beginning with these four questions:

1. What is your current situation, financial and otherwise?
2. What do you need in order to accomplish your personal goals?
3. Can your exit of the business facilitate that?
4. If not – if there is a “wealth gap” between where you are now and where you want to be when you exit – how can we solve for that in a five-to-10-year runway? 

The runway is key to how smoothly your succession plan goes.

2. Give Yourself a Sufficient Runway

The sooner you can start planning to sell your business, the better. 

A five-year runway is a great start for any succession plan, whether the buyer is external or internal. With an internal perpetuation plan, the longer you can go – up to 10 years – the better. 

Why so long? A few reasons, chief among which is funding. External buyers typically come with much deeper pockets, while internal buyers – unless they’re independently wealthy – are buying your business using their current income from the business. 

A longer runway gives your internal buyers more time to get the money together or earn their way to ownership through stock options. 

It also gives you more time to train up the owners in what it’s like to be the head honcho, giving them a better chance of success.

All of this fits under the first factor: your personal goals. Without proper funding, you may not get as much money out of your business as you need for retirement. Without proper training, your legacy could go up in smoke without you.

Like I said, the longer the runway, the better.

3. Maximize the Value of Your Business

If you’re selling your business to an internal buyer, chances are you’ll agree on a price several years before the actual sale. Before you do that, you’ll want to be sure to address your EBITDA.

As a business owner, you’ve probably heard of EBITDA – Earnings Before Interest, Taxes, Depreciation, and Amortization. It’s the primary building block for business valuation. As a result, it’s your best tool when it comes to maximizing the value of your business.

Before having your business valued, you can maximize the value by doing things like minimizing spending, taking a lower salary, and limiting hiring.

The thing is, internal succession plans present a balance that can be rather difficult to strike. That’s because while you want to get the highest price you can for your business, you also need to…

4. Keep the Business Affordable for the Buyers

If you’re selling to an external buyer, then getting as much money as you can is probably the most important thing to you. That’s okay – it’s your life’s work, after all.

Internal succession plans, on the other hand, come with a personal element, which means you’re more inclined to find a balance between getting as much as you can for the business without bankrupting the buyers – especially if you’re selling to your children or other family members. 

Again, the length of your runway is key. An internal succession plan allows you to extend the purchase of shares longer than you typically would with an external plan. You could even build the buyout into their benefits plan by offering stock options that allow your successor to slowly gain control over several years.

5. Manage Your Emotions

Regardless of what anyone else says, business is personal. Selling your business is one of the most emotional things you will ever go through – especially if the buyer is internal.

What makes an internal perpetuation plan so much more emotional than an external one?

With an external plan, you have the option to just quit cold turkey. You get your money, the new owner takes over and you’re out. 

With an internal exit plan, you will inevitably overlap with the new owners – it’s built into the process. That can be a blessing for reasons we’ve already addressed: more time for the buyout, time for training, they already know the business, etc.

But it can also be a bit of a curse. It’s kind of like having a second-string quarterback. Sure, they’re on your team, but you just know they’re watching you from the sidelines waiting for their chance to be in your position. It can significantly change the dynamic.

In addition, the best exit plans are set up to slowly remove the owner from day-to-day operations to prepare the business to function without you. That sounds great, but the reality is that every time you take a step back from your business, you give up a little more control. 

After helping countless business owners through this process, I can say that letting go of “the way I did things” is harder than you may think. Things will change. The new owners will start moving in a different direction than you might have. Watching all of that happen with one foot out the door and one foot in can be very difficult.

6. Set the New Buyers Up for Success

As you move toward the exit, one of the best moves you can make is to help set the new owners up for success. 

• Bring them into key client relationships to help prevent a mass exodus of clients after you leave. 
• Praise them to the rest of your team to help create a positive impression. 
• Invite them into budgeting sessions and other owner-only tasks you do. 
• Be transparent with the numbers so they know exactly what they’re getting into. 

As the departing business owner, the best path you can build toward ownership is also a path to leadership.

Are You Considering an Internal Succession Plan?

With the right plan (and a long enough runway), you can get the best of both worlds: selling to someone you know and getting the most out of your business.

Want help thinking through the runway to your exit? Drop us a line – we'd love to help.