Business Protection - Grooming Your Replacement: Six Tips


There's a fatal flaw in the retirement plans of many small business owners: After pouring a lifetime of sweat, time and capital into building the business, their rough-sketch strategy is to sell out someday for a ton of money then settle back and enjoy a financially secure retirement. Many business owners are so sure this will happen that they don't bother to make any other retirement plans.

Whether or not you have a possible successor for your company, you should begin mapping out your retirement strategy today. Consider grooming your own replacement — someone who will buy your company when you're ready to retire. Maybe this person is a current co-owner (but be careful if he or she is about the same age as you, who will be counting on retiring around the same time). Or it could be a son or daughter active in the business, or a younger key employee. Here are some tips to help:

  1. Be cautious. Make sure your heir apparent is the right person in terms of temperament, personality, competence, and personal goals. In most cases in which grooming a successor has worked, the choice was obvious from the start.

  2. Set up a probation period so you can terminate the relationship if you find that this person simply will not work out.During that period, keep everything informal, strictly verbal. At the same time, even when they go to a formal agreement, make sure it contains a termination provision. They know that dealing with an incompatible successor could tear the company apart leaving everyone with nothing.

  3. Create golden handcuffs and incentives to ensure that their replacement stays until the baton is passed. An ambitious successor needs and deserves gradually increasing authority and benefits. Options include deferred compensation or the opportunity to acquire partial ownership prior to your retirement. Both parties need something to win by sticking to the agreement and something to lose if it falls apart.

  4. Put it in writing, along with the help of your attorney — locking in who does what and gets what and spelling out all details and caveats, including how to establish the final valuation of the business. This formal buy/sell agreement protects everybody.

  5. Build in a funding mechanism. This is crucial. No matter how good the terms of the buy/sell agreement, it will be worthless if the money is not there when needed to carry out the plan. Under one option, the successor may be able to purchase the company from ongoing profits. Other options include setting up a sinking fund or allowing the successor to simply borrow the money. These options may work. However, they may not be appropriate for you. Another recommended funding vehicle to consider — that can protect your family in the event of your disability or premature death — is life and disability income insurance. (Products available through one or more carriers not affiliated with New York Life; dependent on carrier authorization and product availability in your state or locality.)

  6. Have a backup plan. As a business owner, you know that very few things go exactly as planned. What if your business hits tough times or your successor dies, becomes disabled or — all too common — leaves because of a personality conflict? Or what if there simply is no heir apparent waiting in the wings? Sometimes, it's best to dismantle the business.

This material is being provided for informational purposes only. Neither EMA Financial and Insurance Services nor its agents provide legal, tax or accounting advice. Please contact your own advisors for legal, tax and accounting advice.


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