Succession Planning Basics: How It Works, Why It's Important

Succession Planning

Investopedia / Julie Bang

What Is Succession Planning?

The term succession planning refers to a business strategy companies use to pass leadership roles down to another employee or group of employees. Succession planning ensures that businesses continue to run smoothly and without interruption, after important people move on to new opportunities, retire, or pass away. It can also provide a liquidity event, which enables the transfer of ownership in a going concern to rising employees. Succession planning is a good way for companies to ensure that businesses are fully prepared to promote and advance all employees—not just those who are at the management or executive levels.

Key Takeaways

  • Succession planning is a business strategy for passing leadership roles on to one or more other employees.
  • The strategy is used to ensure that businesses run smoothly after employees retire and leave the company.
  • Succession planning involves cross-training employees to help them develop skills, knowledge, and an understanding of the business.
  • Plans can be long-term, which are meant to account for future changes, or for emergencies whenever anything unexpected arises.
  • There are many benefits to succession planning, including inclusivity if companies have a strong plan to diversify their workforce.

Understanding Succession Planning

Succession planning is a contingency plan. It is not a one-time event. Rather, it should be reevaluated and updated each year or as changes dictate within the company. As such, it evaluates each leader’s skills, identifying potential replacements within and outside the company and, in the case of internal replacements, training those employees so they’re prepared to assume control.

In large companies, the board of directors typically oversees succession planning in addition to the chief executive officer (CEO), and it affects owners, employees, as well as shareholders. A larger business may train mid-level employees to one day take over higher-level positions. For small businesses and family-owned companies, succession planning often means training the next generation to take over the business.

The process takes a lot of time and effort. As such, it requires:

  • Recruitment or Proper Hiring: The goal is to choose candidates who are capable of rising through the ranks in the future. For example, an experienced person from another company might be courted and groomed for a higher position.
  • Training: This includes the development of skills, company knowledge, and certifications. The training might include having employees cross-train and shadow various positions or jobs in all the major departments. This process can help the person become well-rounded and understand the business on a granular level. Also, the cross-training process can help identify the employees that are not up to the task of developing multiple skill sets needed to run the company.  

Businesses may want to create more than one type of succession plan. An emergency succession plan is put in place when a key leader needs to be replaced unexpectedly. A long-term succession plan, on the other hand, helps the company account for anticipated changes in leadership.

According to human resources (HR) experts, succession planning involves preparation rather than pre-selection. This means that those responsible must identify the skills, practices, and knowledge. Although it may seem like a complex process, it doesn't have to be, especially if businesses and leaders are able to organize and plan ahead of time. The whole process can take anywhere between 12 to 36 months.

In small companies, the owner alone may be responsible for succession planning.

Special Considerations

One way to succession plan in a business partnership is for each partner to purchase a life insurance policy that names the other partner as the beneficiary. This type of succession plan is called a cross-purchase agreement and allows the surviving partner to continue operating the business.

Here's how it works. If one partner dies at a time when the surviving partner would not otherwise have enough cash to buy the deceased partner’s ownership share, the life insurance proceeds make that purchase possible.

Succession planning is also commonly known as replacement planning and often involves passing on ownership of a company to someone else.

Benefits of Succession Planning

There are several advantages for both employers and employees to having a formalized succession plan in place:

  • Employees know that there is a chance for advancement and possibly ownership, which can lead to more empowerment and higher job satisfaction.
  • Knowing there is a plan for future opportunities reinforces employees' career development.
  • Management's commitment to succession planning means that supervisors will mentor employees to transfer knowledge and expertise.
  • Management keeps better track of the value of employees so positions can be filled internally when opportunities arise.
  • Leadership and employees are better able to share company values and vision.
  • A new generation of leaders is needed when there's a mass exodus of people from the workforce into retirement.
  • Proper succession planning benefits shareholders of public companies, especially when the next candidate for CEO is involved in business operations and is well respected years before the current CEO retires. Also, if investors observe a well-communicated succession plan, they won't sell the company's stock when the CEO retires.

Succession planning can also cultivate a new generation of leaders, thereby providing an exit strategy for business owners who want to sell their stake.

Succession Planning and Diversity

One of the key drivers to success for any company (whether it's a small business or a large corporation) is how inclusive it is. Companies are now recognizing the need to diversify their work environments in order to remain competitive and successful. Not only does it boost employee morale, but it also aims to broaden the pool of talent and make attempts to fight bias.

But how do companies do this? This involves a well-structured succession plan that includes hiring individuals from different backgrounds, those who have different leadership abilities, and people who bring different experiences to the table. The plan should also include removing any barriers that may exist internally for employees of all levels and ensuring a comfortable work environment for all employees.

This only works if succession plans are put into place wholeheartedly rather than to boost corporate images.

How Does Succession Planning Work?

Succession planning is used by businesses to streamline the process involving a change of leadership or ownership. It involves recognizing internal employees who merit career advancement and training them to assume new roles within the company. These plans only work if companies take the steps necessary to prepare. Plans are often long-term to prepare for inevitable changes in the future. Emergency plans can be set in place to account for unexpected changes.

What Is Succession Planning in Business?

Succession planning is an important part of any business to help it run smoothly and without interruption whenever there needs to be a change in leadership. Changes can be the result of people leaving the workforce (changing companies, switching careers, or retiring) or if there are unexpected circumstances, such as the death or displacement of a team member.

What Are Some of the Common Mistakes Companies Make During Succession Planning?

Succession planning requires careful organization and (as the name suggests) planning. Companies may miss opportunities or make missteps if they can't communicate their vision with employees, don't adopt a formal agreement or plan (including a shortlist of candidates and conducting regular reviews of positions and employees), assume their talent has the skills and knowledge to advance and succeed, fail to use succession plans for all employees, and ignore the need to diversify their talent pool.

Article Sources
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  1. SHRM. "Engaging in Succession Planning."

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