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.