Succession Planning: How It Works, 5 Steps to Take

Succession planning is the act of choosing and training employees to replace company leaders when they leave. In some cases, for privately held businesses, succession planning includes planning for a potential ownership transfer when the owner retires, dies or steps away from the company.

Succession plans differ depending on the company’s overall goals and can change over time. For example, a family-owned business may reserve some jobs for relatives, as in the TV show Succession.

However, for most businesses, succession planning means finding good leaders who can take over when current leaders leave, including plans for replacements in other management roles.

Succession planning works differently than a traditional hiring process. It’s an ongoing process that works as a contingency plan in case things change unexpectedly, and companies should have a plan in place long before the need arises. Here are five key steps:

1. Review key roles. Identify the leadership positions in which a departure would significantly affect the business.

2. Align on requirements. List out the traits needed in the key role. This list should go beyond functional job requirements and include soft skills, personality traits or other indicators you think are essential.

3. Identify potential successors internally. Identify potential leaders in the organization. Remember that performance in a functional role doesn’t always predict leadership potential.

4. Provide development opportunities for potential successors. Instead of a traditional interview process, assemble a team of possible successor candidates and give them a project that’s significant to the entire company or affects every part of the business.

5. Consider insurance. Many businesses purchase key person insurance to cover their most valuable, essential employees. The death benefit from the insurance policy can assist with business costs and bridge the gap during the replacement period.

1. Rushing to choose a successor

The urge to make a succession plan leads some businesses to move too quickly, naming a successor before the position opens.

“Tapping an heir apparent can be really bad for the morale of the organization,” says James Vardaman, a professor of management at the University of Memphis and a succession consultant for small and medium-sized businesses. “And it really isn't good for the heir apparent either.” Doing this can lead to resentment, complacency and retention issues.

Choosing an heir apparent can also limit a business’s ability to adapt to circumstances that might change between naming the would-be successor and when that person actually assumes the role.

2. Relying too much on current job performance

In the TV comedy “The Office,” the character Michael Scott bumbles through his role as office manager, displaying behavior that would make any HR department shudder.

Vardaman says this illustrates the most common mistake he sees businesses make when succession planning: choosing a leader based on performance in a functional role. For Scott, the skills that made him successful in sales didn’t translate well when he moved into a leadership role.

“Organizations too often just say, ‘You know, this person's the best at their job, so they're the natural person to come in,’” Vardaman says.

3. Not thinking about the big picture

Succession planning can be a great way to foster growth. “A good succession plan develops talent in general,” Vardaman says. “It's not just about finding the next person to be in this job or that job.”

A business run by a family may also require a slightly different approach. For example, the role of CEO might be reserved for a child or other relative. This presents unique challenges, such as managing the expectations of nonfamily members in the company and addressing any intrafamily issues that could arise. In this case, succession planners need to consider whether hiring a family member aligns with the company's ongoing needs.

Succession planning can include the transfer of ownership and the responsibilities that come with it. If the beneficiaries of a key owner aren’t suited to own and run the business, the current owner can sell the business, which can include setting up a buy-sell agreement with co-owners to buy out one another’s share in the event of disability, bankruptcy, retirement or death.

Businesses in probate

Ownership in a business is an asset, which means it may need to pass through probate. However, using an irrevocable trust — such as a grantor retained annuity trust (or a GRAT) or an irrevocable life insurance trust (or an ILIT) — can ease the complexity surrounding these situations:

• A GRAT may remove future appreciation of the business from the owner’s estate. This minimizes gift and estate taxes when transferring assets to heirs. 

• An ILIT can own a life insurance policy on the business owner. Making the trust the policy owner separates the death benefit proceeds from the business owner’s personal estate, possibly minimizing estate taxes. The ILIT also provides the business owner’s heirs with more immediate liquidity or access to funds to cover business expenses until they can find a suitable buyer for the business interest.

» MORE: Should you set up an irrevocable trust?

As a business owner, personal and business affairs are often intertwined. Consulting with estate planning attorneys and tax and financial advisors ahead of time can help you find the right solution to ensure that your personal and business succession plans align.

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