Don’t Wait to Begin Business Succession Planning

This article is also featured in the September 14, 2020 issue of MiBiz

A common and costly mistake when it comes to business succession planning is not starting the process early enough. By waiting too long, an owner runs the risk of not having the right people in place to run the business, as well as having much of the business’ value consumed by estate taxes. Either misstep can and sadly often does cause a business to fail when it passes from one generation to the next.

Here’s the good news: With careful planning conducted alongside experienced business advisors, including legal counsel, the risks that befall many businesses during an ownership transfer can be avoided. However, it’s time to act with a sense of urgency. Historically, high estate taxes have been a big impediment to succession planning. Currently, estate tax exclusions are very favorable, enabling forward-looking owners to preserve the value of their businesses for future generations.

But now is the time to act. The upcoming election could drastically impact the availability of favorable succession planning strategies, some of which are currently scheduled to sunset in 2025. Business owners, particularly those over 50, need a plan in place now so that they are ready to take advantage of potentially-last minute opportunities after the election.

First Steps in Business Succession Planning: Think about succession planning the way you would about any issue of strategic importance: begin by exploring your objectives, identifying likely obstacles, and defining your goals. The key to success is starting the planning process early and assembling a qualified team of legal and financial professionals who understand the common pitfalls and opportunities.

Want to keep the business in your family? After identifying the family members who will play key roles in your business in the future, it is crucial to ensure that the company’s management team is ready to support them and that the transfer can be accomplished without insurmountable estate and income tax liabilities.

Interested in transferring ownership to a large group of employees or smaller subset of key managers? When there is no co-owner or family member to succeed you in your business, selling to members of your existing team can provide stability and an incentivized workforce with an ownership stake.

Planning a sale to a financial or strategic buyer? Selling to a third-party, such as a private equity fund, may be a viable option for a business. However, if you decide to go this route, be prepared for a rigorous process. A professional buyer will do a deep dive on the business and ask pointed questions about its financials and operations. Refined systems and processes, clean financials and legal records, and clear protocols for tax and legal compliance will make the business more attractive and fetch a higher valuation.

Tactics to Enable Succession

Once your objectives are clear, it’s time to execute your plan with the assistance of legal counsel and other appropriate advisors. The right strategy must be matched with the right method of execution.

Family Transfer. There is much more involved with transferring your business to family members than a simple will or trust. There are numerous strategies that can save millions in estate and other taxes for the right business and family. Many of these strategies depend on maximizing estate tax exclusions, which are scheduled to be cut in half in 2025 and may be reduced or eliminated earlier depending on the outcome of the upcoming election. It is highly unlikely that the tax environment will get any better than it is today. Business owners should consider now discussing with their advisers strategies such as lifetime gifting, selling equity to an IDIT, employing a GRAT or generation-skipping trust, leveraging life insurance, and other estate-planning tactics to further their succession planning objectives.

ESOP Transfer. An “Employee Stock Ownership Plan” or “ESOP” is one of the most effective tools for transferring ownership because it  can create a market for the sale of a privately held company. It’s a strategy that enables a business owner to sell his or her stock to a separate legal (and tax exempt) entity and enables employees to acquire a beneficial ownership stake in the business. While the company continues operations it may make contributions to the ESOP, which is a qualified retirement plan, to provide tax-deferred retirement benefits for its employees. There are also tax incentives for sales of certain stock to an ESOP that help owners minimize tax consequences. Overall, an ESOP allows for a business’ culture, operations, and identity to remain intact while the owner transitions out of the business.

Leveraged Management Buyout. A sale to a key manager or group of managers is a common strategy that banks and other lenders are often willing to finance. Key issues to consider include the terms of any likely financing, whether the current owner is willing to help with the financing, how to ensure that the buying managers “have skin in the game,” and whether the management team is ready to run the company after the owner retires. These issues and others are easiest to address with advance planning.

Third-Party Transfer. It is common for owners to sell their business to a competitor or other strategic buyer when it is time to retire, or to a financial buyer such as a private equity or similar fund. We find that most businesses find themselves unprepared to sell, and that many sellers are surprised by the rigorous sales process and its challenges. Time spent now preparing the business for sale may very well help to ensure a prompt and successful sale at the best possible price.

According to PwC’s 2019 US Family Business Survey, only 23% of family businesses have a formal succession plan in place. With clear objectives, a sense of urgency, and experienced counsel in place, you can help ensure that your business, and your future, are secure.