Springfield Business Journal Articles


You're A Success, But Who Will Succeed You?

If you're like most entrepreneurs, you've devoted yourself to your business, and you may not be able to even think about leaving. But you will leave one day (whether because of a sale of the business, death or disability), and your departure could destroy your business if you don't plan for it.

Succession planning is one of the most difficult tasks for most business owners because of the emotional issues involved. The business and the owner often seem like one, and the owner may refuse to relinquish any control. If the owner fails to properly train a successor, the business may flounder.

Once the emotional issues have been addressed and a successor or successors have been identified, there are complex legal and financial issues. The problems and solutions can be very different depending upon whether the successors are family members or unrelated parties.

If the successors are unrelated parties, such as key employees, the first step is generally a buy-sell agreement. This agreement will specify when the successors can acquire the business and at what price. The buy-sell agreement can be triggered at the owner's death, disability or retirement. The price can be stated as a set amount, as a formula, or as determined by an appraisal at the time of the sale.

After the price has been determined, you must address funding. How will the successors pay to acquire the business? Will they be allowed to pay over time or must they pay all at once? Should the successors purchase life insurance on the life of the owner which they can use to purchase the business at the owner's death? Should the company own the insurance or the successors?

The owner must also consider estate tax issues. As of January 1, 2006, the estate tax exemption amount is $2,000,000, and the estate tax rate is 46%. If the owner allows the successors to purchase the business over time, will his estate have sufficient liquidity to pay estate taxes? Should the owner purchase additional life insurance to pay estate taxes? If so, the insurance should be held in a life insurance trust or it will only increase the estate tax liability of the owner.

Although estate tax can be daunting, most closely held businesses do not fail because of estate taxes. They fail because of fighting among family members or because no one who remains has the ability or the vision of the owner.

If there are multiple owners, there are multiple options. If one owner dies, the business can buy back his interest, or the other owners can buy the interest from the deceased owner's estate. Each of these options will have different income tax consequences depending on the type of entity of the business, such as an S corporation, a C corporation or a partnership.

The owner may wish to transfer an ownership interest in the business now to the successors without giving up control of the business. This can be accomplished in several ways. If the business is a corporation, the corporation can be re-capitalized into voting and non-voting shares. Non-voting shares can be transferred to the successors giving them an ownership interest in the business but keeping control in the owner.

If the successors are family members such as children, the owner may wish to transfer an interest in the business to the children in trust. The owner cannot serve as trustee of the trust, however, the owner's spouse can serve as trustee. In this way, the owner can transfer ownership for the benefit of his family but know that control remains in the hands of someone he trusts.

A buy-sell agreement can also be used in family situations. If the owner has several children but only one is active in the business, he may wish to sell the business to that child rather than give it to her. In that case, a buy-sell agreement can require the owner's estate to sell to the child and specify the terms of the sale. The purchase price can be for less than fair market value, but such a price will not be binding for estate tax purposes. For example, if the owner and his daughter execute a buy-sell agreement specifying a purchase price of $5,000,000, that price will be binding on the owner's estate. However, if the fair market value of the business is $10,000,000 at the time of the owner's death, estate taxes will be owed on the entire $10,000,000.

The owner's estate planning documents must also be coordinated with the succession plan. The owner's will must direct the disposition of the business, and the owner should have a trust or power of attorney to provide for control of the business in the event of his incapacity.

Ultimately, succession planning is a comprehensive task involving business, financial, tax and family issues. A successful plan will probably require the input of an attorney, an accountant and a financial planner or insurance agent. It may also require a consultant to deal with personal and emotional issues. If properly implemented, however, the succession plan can allow a business to survive the departure of the founder and to flourish, rather than to disintegrate.
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