Who is heir to your throne?

Why succession planning is important to you and your business.

by Bart Basi

Who will operate your business in the future? Many business owners don’t know the answer to that question and don’t want to think about it. On average, only 30 percent of companies survive to a second generation, only 12 percent of those survive to the third generation, and only 3 percent of those survive to a fourth generation. Having a succession plan can help to strengthen these numbers and ensure that your business will be passed on to future generations.

Succession planning is the “will” for the company. It helps to identify who will own the company, who will manage the company, and how the company will be transferred. This article will help identify why succession planning should be a priority to you, and what exactly can be found in a succession plan.

Why succession planning is important
The basic purpose of succession planning is to achieve the maximum benefits from your labor, both during your lifetime and at death. You achieve these benefits by proper planning and proper transitions of your business assets.

First, ask yourself if you have provided for adequate income during your retirement or upon your death. If not, proper planning may help increase the benefits you receive upon retirement or help your loved ones upon your death. Often, loved ones are responsible for debts, estate expenses and taxes. Proper planning can reduce, if not eliminate, these responsibilities on your heirs.

Second, you must select a successor. You must select someone who is competent, knowledgeable, dependable, and who desires the role. You cannot select someone without the will or desire to run your company. Communication is essential for this purpose. The proper communication allows you to identify those who fit the criteria to fill your position.

You can’t expect a successor to make decisions for the first time upon your death. A transition period is essential to a successful plan. Factor in time to train and mentor your successor so that person will succeed both personally and professionally. This will also provide you with the comfort level you may need. Proper planning will provide you the time you’ll need to identify the successor and allow them to work up to their eventual leadership position with you as their mentor.

Advanced planning allows you to identify how the transfer will take place. You may decide to sell or gift the business to family members or key employees. Alternatively, you may decide to seek a higher bid from a competitor. Regardless of how you transfer your business or to whom, succession planning will help identify the advantages and disadvantages of each possible plan. This type of preparedness helps eliminate taxes and liabilities for your estate heirs and your successors. In addition, proper planning can lead to a happy retirement with more cash and less taxes.

These are just some of the reasons to have a succession plan in place for your business. Whether you are thinking about retirement or have just entered the market, it is never too late or too early to begin to develop and implement a succession plan.

The plan
The first element of the plan is selecting a successor. This process can be tedious and time consuming, which is another reason why you need to address a succession plan immediately. The choice of successor should be based on the best interests of the company and may require resolving some family and personnel issues prior to selection. Involving family members and key employees will help facilitate the process and provide for a smoother transition. It is also important to include the needs and concerns of those employees or family members who will not be involved in the management to help solidify their support and loyalty to the company. No matter how it is done, address this step early.

The next step is to prepare the legal documents necessary to implement the plan. The single most important document in a succession plan is a buy-sell agreement. A good buy-sell agreement will automatically provide for the succession of the company (including transfer of ownership and control), will determine the value of the company and identify what is needed to reduce the tax liability. A properly drafted buy-sell agreement will help ensure an orderly passage of the company to the next generation and assist in establishing your retirement program.

The buy-sell agreement will dictate the taxes and liabilities that the company will be responsible for during the transitional period. Estate taxes are normally calculated on the fair market value of the company at the date of death. When a buy-sell agreement does not exist, the IRS steps in and fixes the value according to its own formulas. This value may have no relation to what your estate received as the beneficial owner of the business. Therefore, it is important to have a buy-sell agreement to help establish the value of your company and reduce the threat of a less favorable valuation upon your death.

Other documents that we have prepared in succession plans include stock redemption agreements, incentive plans for employees, employment contracts for those who are considered key employees, life insurance policies, wills and trusts. These are some examples of the many types of documents found in a succession plan.

As you implement and carry out the plan, it may require subtle changes to accommodate the styles and goals of the new owners. In addition to documents, you may need to create or eliminate positions. For example, if you believe the value of your business will increase by appointing a CEO, the succession plan may include a resolution creating such a position.

Each of these documents takes a considerable amount of time and input to ensure that your “will” as an owner is followed. It is imperative that all documents in the plan be prepared by competent, experienced professionals who will look out not only for your interests but for the interests of the business and future generations as well.

A succession plan is a difficult thing to think about. If done properly, it can provide the foundation for the future operation of your business. Knowing who will succeed you, how they will do so, and when the succession will take place will help to preserve the value of the company. The decisions that must be made to complete a succession plan involve complex personal issues and difficult questions of law and tax. The only way to create the right plan is to work closely with a qualified specialist who is knowledgeable about you and your business, so that you are well informed of the choices available to you.

Bart Basi of the Center for Financial, Legal & Tax Planning, can be reached at (618) 997-3436.

This article originally appeared in the 2003 I.D.A. Business Expo issue of Progressive Distributor. Copyright 2003.

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