How Is Your Business Succession Plan Coming Along?

Say, what? That’s right, your business succession plan. You are probably like most folks who spend hours and years building their businesses into a success, but spend little or no time contemplating how and when they will retire from the business, or who will own and run the business after they are retired, deceased or incapacitated. Will those persons be prepared for the responsibility? Are the right people being groomed for the position now? How will your survivors receive income from or realize the value of the business upon your demise? The future success of your business and possibly the well-being of your family depend upon your spending some time grappling with these and other issues in order to develop a business succession plan that works.

First, as with any venture, choosing an “exit” strategy is essential. Exit strategies include retirement, sale to a third party, transfer or sale to family members or trusts for their benefit, sale to an employee stock ownership plan (ESOP), and “going public,” just to name a few. In deciding on an exit strategy, you must decide whether you want to retire at all, and if so, when, and how much money you will need to do so. If you plan to retire from an active role in management, do you also desire, or will it be necessary, to also part with ownership as well? In other words, can or should ownership and control be separated? How will retirement be funded? Many business owners live out of the business and have little outside investments and little in retirement accounts or other tax-deferred arrangements. Will the business need to be sold in order to fund retirement? If so, to whom may/should it be sold? Family? Competitor? Grantor Trust? ESOP? Should the stock or the assets be sold? Can income taxes be deferred or eliminated upon such a sale? Probably so. Can the company be reorganized to leave you voting or non-voting cumulative preferred stock? Perhaps. Should you make a subchapter S election in order to get cash out of an incorporated business free of self-employment tax and double income taxation? Maybe so.

Is it important to you that the business stay in the family? If so, are there family members willing and able to take over management of the business? If not, are there non-family members to whom management can be entrusted? Do you currently have partners in the business? If so, how do you coordinate the transfer of interests among the partners or family members?

The exit strategy chosen may be preempted by unanticipated events such as an untimely death or disability. How would such an event affect the exit strategy? Consideration obviously should be given to and contingency plans made for such an event.

Next, a business succession plan must be developed that encompasses these considerations. Every situation is different. For the sole owner who wishes to leave the business to the next generation, some of the questions that must be asked include: Are there members of the next generation willing and able to take over the reigns of the business? Will there be both “inside” and “outside” children? If so, how are they to be treated equitably? Are there other assets available to balance out a bequest of the business to the “inside child”? How will your heirs pay death taxes and other costs to settle your estate? Will a sale or liquidation be necessary? How will your spouse be provided for after your death during his or her remaining life?

If you are a co-owner, then the considerations will likely be different. You will not only be concerned about your own exit strategy, but that of your partner(s) as well. If you or your partner becomes disabled or retires, will the other of you be able to afford to pay the disabled owner’s salary from cash flow? How will your or your partner’s absence affect the ability of the business to continue at current levels of performance? Are you willing for your partner to sell his interest to a third party? Does the company have assets or cash flow to purchase his interest, and if so, how will it be valued?

If your partner dies, are you willing for his interest to pass to his heirs? Do you want to be in business with his spouse or children? If not, does the company have the wherewithal to purchase his interest from his estate? How will he be replaced? Are there funds to purchase your partner’s interest and hire his replacement as well?

A good business succession plan must address these concerns. Obviously, for most owners of a successful small business, professional guidance is crucial to preparing and implementing a solid business plan. This is not an area in which you would be advised to “skimp.” A good team of advisors is essential because business succession planning involves many disciplines–accounting, legal, financial, tax and insurance–to name a few. Quite a few business succession planning cases would also benefit from the involvement of a mediator or even a psychologist.

There are many tools and techniques that are commonly used in business succession planning. Some of the tools include wills, buy-sell agreements, key-man life insurance, buy-out life insurance, disability insurance, installment sales, sales to ESOPs, lifetime gifts, qualified and non-qualified deferred compensation plans, corporate reorganizations, estate tax deferral election (§6166), use of holding companies, use of voting and non-voting or preferred stock, estate freeze techniques, corporate redemptions, “going public,” and others. Choosing the right combination of tools for the applicable situation requires you as the business owner to answer a lot of difficult questions, and further requires the knowledge and skill of a team of professional planners. The process should be seen as an investment in your future, your family’s future, and the future of your business.

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