by Dudley Q. Sharp, Jr.
Society uses bridges for many reasons. They are used to move people and goods for both short and long distances. In some cases, bridges are used to cross small streams and bypass dangerous intersections. In other cases, bridges are used to traverse deep canyons, large rivers or even great distances across the ocean. Implementing business succession planning to transfer wealth to future generations is much like the design and construction of a bridge, and there are just as many variations depending upon your place of origin and desired destination. But, business succession planning involves more than merely planning to move wealth from one generation to the next, it takes time and careful consideration.
The key word in business succession planning is success. While many business owners are “head down” and charging hard at developing a successful business model, key areas of their business are often neglected. Business owners should insure that their successes will both support their families in retirement and will also be transferrable to future generations. While there are many elements to a business succession plan, in this article I will outline the three phases business succession planning can be divided into.
Statistics show that many first generation businesses do not survive into the next generation. One reason failure occurs is a lack of or a poor business governance model. Many business owners will bring family members, partners, or even friends into their business and will transfer stock to those individuals as a reward. However, when the time comes for expansion, financing, sale or other significant business transactions, they find their goals are sometimes impeded or hampered by minority shareholders who hold the majority hostage. Creating an ownership structure that protects equity and control is essential.
Getting into business with partners can be as difficult and complicated as getting out. This is particularly true when other partners are contributing promises to provide future services in exchange for receipt of a business interest. If not properly structured, an exchange of equity for a promise to provide services can generate significant tax liability for both the organization and the service provider. In addition to the tax consequences, business owners must also protect their interests in intellectual property, especially when a contributing partner is either contributing intellectual property or agrees to create intellectual property in exchange for stock.
Death, disability and divorce of partners can be terribly disruptive to any business. Many business owners have not considered what would happen if their business partner died. (If the business partner’s or children inherited his ownership interest, the owner will have new partners.) Depending on how an entity is organized, management of the organization can become paralyzed. Having a business structure that provides for continuity of management is vital to both current and future success.
Conversely, what would happen to your family if you passed away? It is not uncommon for many partners to grant options to remaining partners or even the partnership to purchase a deceased partner’s interest over time. However, unfunded buyouts carry significant repayment risk for the survivors and disputes over value can lead to costly litigation. Adopting clear buy-sell agreements that address funding issues and security for repayment is important.
Keeping the Doors Open
Establishing and maintaining sound business policies and procedures will add value to a business. Some matters to consider are discussed below.
Successful business owners establish key relationships and devote many hours and resources to cultivating customer and supplier relationships. Too often, they find that an ambitious former employee or partner is now using relationships, experience or knowledge gained while employed at the business for the benefit of a competitor. The businesses’ customer and contact lists are valuable property that can and should be protected through non-competition, non-solicitation and non-disclosure agreements.
Keeping and maintaining key employees in this age can be difficult. Savvy business owners are having success in maintaining key employees through various incentive programs. Whether through formal bonus programs or through use of non-voting stock, these tools help business owners retain key employees and allow them to share in the success of the business. Ensuring the right to reacquire the stock upon departure of the employee or partner must also be considered.
Careful tax planning and administration of tax payments is vital to the long term success of a business. Securing a competent certified public accountant will go a long way towards providing necessary advice regarding income reporting and tax payments. While the IRS generally does not want to own a business, the agency does have significant collection and enforcement powers which can cripple and even cause the death of your business.
Planning Your Exit
Long before business owners begin to eye the golden years of retirement, they should examine their exit strategies. One consideration is to plan the exit for profits. Leaving profits in the business will expose the funds to the liabilities of the company. While many business owners leave profits in the business for future growth and expansion, distributing profits and retained earnings from the business can provide significant asset planning protection opportunities. However, timing of distributions must be carefully planned to minimize income tax consequences.
Other considerations for an exit plan may include selling stock or selling the assets of the business to an outside party. While businesses are purchased and sold on a regular basis, it is rare to receive a 100 percent cash buy out at closing. Usually, the buyer will require at least some portion of the purchase price to be deferred for a variety of reasons. Whether an owner is selling their business with seller-financing, or part of the purchase price is deferred as an “earn-out,” they will need to consider both the security for payment and the ability of the successor to pay the purchase price.
On the other hand, business owners may consider transferring their business to a family member. Providing for and protecting family members not involved in the business is complex. If an owner contemplates an outright gift of the business to an involved family member, those family members not receiving an interest are likely to “cry foul.” If the business is sold to a family member, the owner must address issues of price and ability to pay as those will become significant concerns for the other non-purchasing family members. Business owners must also plan for tax consequences of the transfer of their business. Careful planning can minimize income, gift and estate taxes when transferring a business.
Maintaining Your Business Succession Plan
Just as bridges require routine inspections, maintenance, or even reconstruction, a business succession plan will need regular attention as well. As business and wealth grow, owners may find the need to widen, expand and strengthen their business succession plan. Hopefully, business succession plans will not resemble a “bridge to nowhere.” Whatever the case, just as multiple disciplines are employed in the design and construction of bridges, multiple disciplines are also essential to a successful business succession plan. Business owners should consult with attorneys, accountants, investment advisors, insurance advisors and other business consultants along the road of life as they design, build, inspect and maintain their business succession plan.
Dudley Q. Sharp, Jr. is an attorney with Burr & Forman LLP in Orlando, Florida. He practices in the firm’s Corporate and Tax Practice Group and works regularly with business owners in starting, buying, selling and transferring business interests.