As the economy progresses through an economic cycle and continues to improve, business owners are seeing the value of their business recover. Now is a good time for business owners to develop a plan for their company’s future, even if retirement is not on the horizon.
A succession plan is a long-term process put in place by the business owner that identifies who the business will be transferred to upon the owner’s retirement. While death, disability or divorce might seem like remote possibilities to business owners, the havoc they leave behind can destroy a business. With a succession plan in place, a crisis situation can be avoided.
The succession process begins with communication and discussion. It is important for the business owner to identify those who are candidates to succeed to the business, which can sometimes be a timely and challenging process. If a successor is not yet qualified to take control of the business, a viable option is to bring in an interim manager or executive to operate the business until the successor develops the necessary skills to take control of the business. Another option is for the business owner to serve as a consultant to the successor by offering their experience and knowledge of the industry to the successor. This also provides cash flow to the retiring owner.
When planning for succession, the business owner will meet with an attorney, accountant and financial manager to examine their current and forecasted income needs and update their estate plan. The professionals will also assist the business owner in determining when will be the best time to withdraw from the business, how to fund the transition, the tax implications of the transition, the source of funds to pay the business owner, and whether the business generates enough income to pay both the business owner and the successor.
During the planning and implementation process, the value resides in the business and control is transitioned to the successors. Upon the completion of the process, the objective is to convert the value into income for the retiring business owner and transfer control to the successor.
Once a successor has been identified and a transition plan is in place, the next phase of the process is to create a buy-sell agreement. The buy-sell agreement:
- transfers the actual value of the business to the retiring owner.
- gives control of the business to the successor.
- defines the timing of the transfer.
- determines the price of the transfer.
- determines the payment terms.
- can include the source of funds to pay for the transfer.
Consideration has to be given to the tax basis for determining capital gains and losses on the sale of the interest in the business, for both the retiring business owner and the successor. Life insurance is often used as a tool to provide the liquidity to pay for the purchase. Also, life insurance is a way of converting value into cash. In a family-owned business, a gifting program to transfer ownership to the next generation is implemented where a percentage of ownership is gifted over a term of ten years or more.
Developing a succession plan requires time, effort and energy, but having a proper plan in place allows a business owner to achieve maximum value for their life’s work and peace of mind knowing the business will continue to thrive upon their withdraw from the company.
Attorneys at CMDA effectively develop succession plans for businesses of all sizes. Even if retirement is not on the horizon, business owners need to start planning for the future. To discuss the development of a plan, please contact our offices.
Christopher G. Schultz, the managing partner of the Firm, focuses his practice on representing businesses in many areas of the law, including business succession planning, entity selection, start-up issues, shareholder and owner relationships, employment matters, mergers, acquisitions, and real estate matters. Additionally, he assists a great number of clients with estate and elder law planning, including wills, trusts, charitable giving, estate administration, irrevocable trusts, gifting and special needs trusts. He can be reached at (734) 261-2400 or firstname.lastname@example.org.