Will Your Business Die When You Die?
Failing to have a succession plan is often the reason family businesses do not survive across the generations. Creating, designing and implementing a succession plan can protect the family’s legacy, according to the article “Planning for Success: How to Create a Suggestion Plan” from Westchester & Fairfield County Business Journals.
If you do not have a business succession plan, and you are the sole owner, your business could become worthless upon your death, resulting in your heirs getting nothing from the business. Alternatively, if you are in a partnership or co-ownership with another business owner, your partner could continue operating the business, but your heirs could be locked out of distributions of profits from the business and locked out of decisionmaking. Almost always, a proper business succession plan should be put into place.
Start by establishing a vision for the future of the business and the family. What are the goals for the founder’s retirement? Will the business need to be sold to fund their retirement? One of the big questions concerns cash flow—do the founders need the business to operate to provide ongoing financial support?
Next, lay the groundwork regarding next generation management and the personal and professional goals of the various family members.
Several options for a successful exit so that your business will not die when you die plan include:
- Family succession—Transferring the business to family members
- Internal succession—Selling or transferring the business to one or more key employees or co-workers or selling the company to employees using an Employee Stock Ownership Plan (ESOP)
- External succession—Selling the business to an outside third party, engaging in an Initial Public Offering (IPO), a strategic merger or investment by an outside party.
Once a succession exit path is selected, the family needs to identify successors and identify active and non-active roles and responsibilities for family members. Decisions need to be made about how to manage the company going forward.
The options listed can be financed in one or a few of these ways: (1) outright payment of cash; (2) the purchase of a life insurance policy on key members or owners; (3) through a seller-financed arrangement (whereby the buyer makes payments over time with the seller securing the business and the assets of the business, much in the way a bank will secure the purchase of a home); and (4) a bank or SBA financed arrangment (whereby the seller gets cash at closing and the buyer pays the bank/SBA over time). Any agreement that you have with a partner should be set forth in a binding “Buy-Sell Agreement”, which can be a stand alone agreement amongst the partners, or a buy-sell provision in your company Operating Agreement.
Tax planning should be a part of the succession plan, which needs to be aligned with the founding member’s estate plan. How the business is structured and how it is to be transferred could either save the family from an onerous tax burden or generate a tax liability so large, as to shut the company down. The sale could be structured as an “asset sale” whereby each individual asset of the business is purchased in total, or an “entity sale” whereby the entity itself (for example, the LLC or corporation) is sold. If your company is categorized as a “c corporation” or an “s corporation” for tax purposes, the sale can be structured as an “entity sale” for state law purposes, but there is still the option of categorizing the sale as an asset sale for tax purposes under Section 338 of the Internal Revenue Code. The bottom line is that you don’t want to create any extra taxes due to the sale, including “depreciation recapture”, and you should know your after tax rate of return (including how much of the sales price will be categorized as “return of capital”, “capital gains” and “ordinary income”). The installment sales method may be a good way of delaying recognition of the gains from the sale over time and avoiding taxes due to tax bracket jump.
Many owners are busy with the day-to-day operations of the business and neglect to do any succession planning. Alternatively, a hastily created plan skipping goal setting or ignoring professional advice occurs. The results are bad either way: losing control over a business, having to sell the business for less than its true value or being subject to excessive taxes.
Every privately held, family-owned business should have a plan in place to establish what will happen if the owners die or become incapacitated.
An estate planning attorney who has experience working with business owners will be able to guide the creation of a succession plan and ensure that it works to complement the owner’s estate plan. With the right guidance, the business owner can work with their team of professional advisors to ensure that the business continues over the generations.
BOOK A CALL with me, Ted Vicknair, Board Certified Estate Planning and Administration Specialist, Board Certified Tax Law Specialist, and CPA to learn more about estate planning, incapacity planning, and asset protection.
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Reference: Westchester & Fairfield County Business Journals (March 31, 2022) “Planning for Success: How to Create a Suggestion Plan”
