Business Basics Series: The Importance of Succession Planning and Valuation Prior to Sale

What is succession planning and why is it so important?

Succession Planning is a process designed to help you prepare for a possible change in leadership or ownership, such as a key employee leaving your business, an owner/operator passing away or the sale of the business. With careful planning, the remaining owners and employees will be able to make quick changes within the business to help it continue to run smoothly. This is because succession planning will have identified potential candidates for key positions and they will have been given additional training and mentorship needed to fulfill the vacant positions. Succession planning can also help boost morale and retention of workers in your business.

How do I create an effective succession plan?

Without a proper succession plan, business-critical issues can arise. Key positions could be left open. Projects could be delayed or critical decisions could go unmade. The company's bottom line and long-term growth could be affected. By creating an effective succession plan, you can help the business avoid these issues and more.

First, you will need to identify the short-term and long-term goals for the business and the resources necessary to meet those goals. Then you will need to identify key positions for which a successor will be needed and determine what type of training will be needed by potential successors. By identifying potential successors early, the learning curve for those positions can be reduced by having current personnel pass their institutional knowledge along to successors well before the position becomes vacant. Lastly, you will need a transition plan setting out when the likely successors will take over the key positions. This should include hiring for any positions that may be left vacant after any changes. While these are some basic steps to succession planning, every business will have different succession plans and you will need to create one that works best for your business.

How do I determine the value of my business prior to sale?

Another aspect of succession planning can be preparing to sell your business, in some cases to key employees but in other cases to third parties. If you are considering selling your business, you will need to determine the value of your business, ideally using a certified business valuation professional. A professional valuation will help you set the appropriate price for your business. Some different ways to determine the market value of your business include income valuation, asset-based valuation, and the market approach. All three of these methods are generally used by business valuation professionals.

Income valuation focuses on projected future earnings and is recommended for businesses that have a large potential for growth. The two common variants of income valuation are the discounted cash flow method and the capitalization of earnings method. The discounted cash flow will determine the present value of your business adjusting for risks involved in purchasing the business. The capitalization of earnings method determines the value of your business by looking at current cash flow, the annual rate of return and the expected return of the business. This method involves taking the net present value of expected future profit and dividing them by the capitalization rate.

Asset-based valuation focuses on the value of the difference between liabilities and assets including tangible, such as machinery and furniture, and nontangible ones, such as patents, trade secrets, and trademarks.

The market approach will determine the value of your business based on the sales and purchases of comparable businesses in the local market. This approach will require that there is sufficient data to compare your business with other businesses.

For assistance with succession planning and preparing to sell your business, be sure to consult an experienced business lawyer. Res Nova Law attorneys can help you with that or we can refer you on if it's not a good fit.