Sole proprietorships often face challenges when it comes to succession planning. There are many reasons why a sole proprietor would want to exit a business.
A significant lifestyle change such as relocation to a new country can affect a sole proprietorship.
It is possible for a sole proprietor to exit the business and have the enterprise continue running despite the exit. Successor identification is one of the key factors in succession planning. Here are a few tips.
The plan shall outline details such as successor identification, training and mentorship, roles and responsibilities, selection of a successor and timelines of succession. Usually, succession occurs in phases and is a process that may take several years.
Decide on your preferred strategy for exiting the business
There are many ways a seamless exit can be achieved. For a sole proprietor, exiting the business entails transfer of the ownership. Therefore, he or she ought to think through the classes of people he can transfer ownership to when the time comes.
The most preferred successor is a close family member. It makes sense for the family to continue reaping fruits from the business in posterity.
If the owner prefers to transfer the business to a family member, then there is need to write a will giving clear instructions on how the transfer is to be achieved.
A second class of potential successors is loyal employees. A business owner can transfer their business to employees once the time comes.
In the succession plan, set out the criteria for identification of the employees. This criteria could include number of years worked, qualifications and so on.
One innovative way of preparing employees for a takeover is by converting your sole proprietorship into a partnership and admitting qualified employees.
When time for exit comes, they automatically become the new owners and continue to run the business as a legacy.
When you admit new partners, you ought to carefully draft the exit clause and ensure that your interests as founder are taken into account. These interests are collectively known as founders’ interests.
You have the option of admitting the new partners as non-equity partners or as equity partners. An equity partner will pay you a capital contribution pegged on the value of the business.
You could also opt to sell the business to existing staff without converting the business to a partnership.
A third class of potential successors is external buyers. Some external investors prefer to buy an already existing business that has a good operational and clientele base. If this is the preferred exit strategy, then you can begin to scout for potential buyers early enough.
An external buyer would want to do a due diligence of your business. It is therefore prudent to run the business with good governance and keep a proper record of business information.
The advantage with external buyers is that they may have the financial capacity to make a purchase compared to existing staff.
However, the disadvantage is that they may dilute stakeholder interest in the business. For example, they may prioritise profitability over staff welfare.
It is therefore important to get a potential buyer who has a strategic fit with the business. If you operate a value driven business, this is crucial.
Ms Mputhia is the founder of C Mputhia Advocates. | [email protected]
