Business Succession Planning

While ninety percent of American businesses are family owned, only about thirty percent of them continue to the next generation. Half of those again make it to the third generation. The most common reason: lack of a business succession plan.

There are many reasons owners fail to plan. In addition to confronting the issues of age and mortality, the business owner also faces potentially giving up his or her life's work – often a venture started, nurtured and grown by them over many years. Business succession planning should start while the entrepreneur is young enough to spend time monitoring the next generation, be it family or otherwise. Around the age of sixty should allow enough time, say five to ten years, for the process to begin and develop.

One of the first things the owner should consider is what to do with the new found time as others take on more of the burden of running the business. Other goals to achieve will help the principal transition to a new life that does not center around the former work and lifestyle.

A business plan should be created, or an existing one modified, to take into account the reality of the succession, ideally with input from the successors. This will allow for the personal feelings, ambitions and goals of everyone concerned to be accounted for. Professional advisors will need to be consulted – accountants for business evaluations and tax planning, lawyers for estate planning and to prepare agreements and financial advisors to determine investment and income strategies for the departing owner and their spouse.

Two of the methods used to transfer ownership are as follows:

1. Gifting using the annual exclusion. Currently at $15,000 per year and indexed to inflation, a couple who files a joint tax return may annually elect to “split” the gift and give $30,000 worth of stock in the company to each child (or any other person for that matter). In addition to the annual exclusion, each spouse may gift about eleven million plus dollars over their lifetimes. A gift tax return must be filed but no tax is due since the client is merely using a portion of their estate tax exemption during their lifetime. So, for example, if you gift out $1,000,000 today, you only have $10,000,000 left to gift tax-free upon your death. If you feel the business is going to appreciate rapidly in the future, now might be a good time to use some or all of the lifetime gift tax exemption to get the business, or property owned by it, out of your estate, to avoid potentially heavy estate taxes later.

If the owner feels that the successors may not be ready to receive substantial portions of the business, but still wishes to move assets out of their name now for tax purposes, irrevocable trusts may be used. These trusts may then further transfer assets to the successors at a time or series of times in the future.

2. The major tool used in effectuating a business-succession plan is the “buy-sell agreement”. The buy-sell agreement stipulates that the seller must sell and the buyer must buy, at a pre-determined value (adjust from time to time between the parties), and upon a predetermined event. Events triggering the provisions of the agreement include, but are not limited to, retirement, disability or death.

There are many forms of buy-sell agreements. The most common is the cross-purchase agreement whereby the remaining shareholders or partners, as the case may be, agree to purchase the departing owner’s share of the enterprise upon retirement, disability or death. The agreement is typically funded with insurance for death or disability but, for retirement, the remaining owners will typically have to fund the agreement through the profits of the business. Upon death, the insurance may still be used to confer a remaining benefit on the departing owner’s heirs. The retiring owner’s retirement income interest may be secured with a private annuity or a promissory note executed by the business itself and perhaps personally guaranteed as well. The foregoing strategies may also include survivor’s benefits for the owner’s spouse.

In cases where there are no other shareholders or partners, key employees should be considered as potential buyers under the agreement since they will best be able to run the business and generate the income needed to fund the owner’s retirement and/or pay the insurance premiums. 

With the right amount of thought and expertise brought to bear on the problem of succession, the business will more likely be one of the few that confers benefits on the owner’s family for generations to come – leaving a lasting legacy to his or her dedication, hard work and foresight.