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Wealth Management > Business Owners > Business Succession Planning

  • Business Succession Planning

    There are a variety of options available when structuring a plan and the sooner a plan is in place the better. In crafting a business succession option, goals must be clearly defined. The business owner must take many factors into account when considering the options including, among others, business strength and savvy of the intended successors and the psychological and emotional impacts of any decision on employees and family members. Finally, all parties must be fully aware of the plan and embrace the plan

    There are various options available to the owners of privately held businesses. These include:

    Transfer of ownership to the next generation 

    Employee stock ownership plan (ESOP) 

    Public offering 

    Recapitalization of the business 

    Sale of the business to a third party 

    Liquidation of the business 

    Buy-sell agreements 

     

    Transfer Ownership to Next Generation

    Approximately one-third of business transfers to the next generation result in success. This creates the need to be proactive with any planning that anticipates involving the next generation and early buy-in by all parties will help lay the foundation for a smoother transition of ownership.

    Children who are active in the business, present both unique opportunities and potential pitfalls. You have the opportunity to take advantage of gifting and valuation discounts that may be used when transferring the business to family members. A Family Limited Partnership often works well in these circumstances. However, there is always the risk of family disagreement and the challenge of balancing the estate for those who are not active in the business.

    There are several creative ways to transfer your business to the next generation including, for example, an Employee Stock Ownership Plan. You should consult with your advisors to discuss the options that may be available to you.

    ESOP

    If you choose to transfer the business to your employees, an Employee Stock Ownership plan (ESOP) may be the solution. An ESOP is a qualified plan designed to benefit all employees and must be non-discriminatory (in other words, provide a greater benefit to one class of employees over another). Unlike other qualified plans, an ESOP can borrow money to purchase investments in the stock of the sponsoring corporation. An ESOP is an excellent method for business owners to plan for transfer of ownership. In addition, there are many tax advantages available to the selling shareholders that assist in maximizing the value of the business.

    With an ESOP, the business owners sell their shares to an ESOP trust. The trust in turn makes annual contributions to the accounts of the employees. One key issue that must be addressed with an ESOP is the concept of repurchased liability. The sponsoring corporation must create a market for the employees to redeem their vested shares upon certain events (e.g. death, retirement). Careful planning attention must be given to this issue.

    Public Offering

    Another alternative is to “go public.” Using this method, corporate shares are offered to the general public and traded on the stock market. This is usually a very expensive option that requires sufficient revenue base and a strong business plan. In addition, it is not optimal as an exit strategy if you are near retirement.

    Rather, this strategy is best employed early in the succession planning process while you are still very active in the business. This option is most useful to provide growth capital for the business, however it can provide liquidity to you in the long run.

    Recapitalization

    If you would like to begin to transfer the business value while retaining control of the company, recapitalization may be the answer. Using this method, tow classes of stock are issued: voting preferred and non-voting common stock. The non-voting stock is transferred either r through sale or gift to the successors. The voting preferred is retained until such point, as the owners are ready to transfer control. This is more commonly appropriate when used with parents and the next generation and may be most useful as a means to provide growth for the business.

    Sale

    You may choose to sell your business to someone who is not currently involved in your business – a competitor, an existing customer or supplier for example. This can be done as a lump sum sale or in the form of an installment sale that spreads the payments and the tax implications over a number of years.

    The sale of the business may be structured as an asset sale, a sale of stock or a combination of both. As a business owner, you are motivated to sell the stock in your business in order to take full advantage of the lower capital gains tax rates (a sale of assets usually subjects a portion of the gain to ordinary tax rates.). However the market and other factors may dictate the nature of the sale. You should discuss the options available to you with your advisors.

    Liquidation

    If there is no market for the business as an ongoing entity or other options are not available, you may choose to liquidate the assets that the business holds, and close the business.

    Buy-sell agreements

    What will happen if you or a business partner wishes to retire? Or dies prematurely? Or becomes permanently disabled? Or gets divorced? (You may end up with an unintended partner – the divorced spouse.)

    Most closely held businesses need to have a buy-sell agreement in place when other partners, principals or shareholders are involved. Most commonly, this agreement states what occurs in the event a partner/shareholder should die, but it should also include provisions for retirement or other departure, disability, and for the divorce of a partner.

    If you are an individual business owner, many of these items still apply; you simply have the added challenge of determining who will purchase your business in the occurrence of one of these events. A properly structured buy-sell agreement stipulates in a binding contract what occurs in each of the events outlined below:

    Death. There are two general structures to the buy-sell agreement in the event of a death – a cross purchase or an entity purchase.

    In a cross-purchase plan, each of the partners owns the life insurance on the lives of the other partners. In the event of the death of a partner, these life insurance proceeds are used to purchase the business equity from the estate of the deceased partner. This type of plan works well, when there are a limited number of partners.

    The entity purchase plan is similar, except the company owns the life insurance on each of the partners, and the company purchases the deceased partner’s shares. This is frequently easier to administer when there are multiple partners.

    Each type of plan has its own strengths and tax implications, so it is important to discuss the decision with a professional who is well-versed in business succession.

    Disability. If a partner becomes disabled, how long will the company continue to pay his/her salary? How long would he/she remain a partner? A disability buy-out provision specifies the method and timing for the buy-out of a disabled partner. This can be done with an installment sale (providing the company can afford the payments) or more likely with a disability buy-out insurance policy. This policy provides a lump-sum benefit to purchase the business shares from the disabled partner.

    Divorce. A divorce decree or the operation of state law can stipulate that all assets are divided between the spouses, including business interests. Unless the buy-sell agreement states what happens in this event, the business may end up with a new, and potentially unwanted, partner.

    Retirement. Perhaps the most complex of all situations is retirement. Who will buy your shares at your retirement? It may or may not be your partners, so your agreement will require a great deal of pre-planning to make sure all parties understand the situation.