Things to Consider When Creating a Business Succession Plan


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Business succession planning refers to a comprehensive strategy for transitioning a business from the current CEO or managing partners to a successive generation. Family-owned businesses require a sound succession plan in order to ensure a favorable transfer of ownership. Because of the significant tax implications, a prearranged restructuring plan makes certain that the baton will be passed to the successors with minimal disruption to the business.

A number of concerns arise regarding the succession of a business. The question of ownership is usually the most immediate of these concerns. While many business owners may have a vague notion of a desire to pass on the business to their children, they may have given little thought to the legal implications of doing so.

A chain of command should be outlined while the head of the business is still actively participating in the business. That may involve the passing of the business to family members, or to another hand-picked successor. When two or more children are involved in the family business, care must be taken so that all family members have a clear understanding as to the succession of ownership. This will give some assurance that the business will continue to operate efficiently and profitably, and will help to avoid disputes that may arise later.

The method used to formally pass the ownership of a business may differ. A buy-sell agreement can be used to sell the establishment to employees, family members, or interested outside business owners. A buy-sell agreement refers to an agreement to buy and sell the interests of the business at a predetermined price, or when an event comes to fruition, such as the death or disability of top management. This agreement will help to establish an estate tax value for the business. The buy-sell option can also be used if the family business is set up as a shareholder arrangement. In such an arrangement, shareholders would be allowed to purchase the interests of the departing shareholder at a set price. However, if a large number of shareholders are involved, this option may become too costly.

Retention planning is the most common tool used to keep the business, as well as its assets, in house. Various methods of asset protection must be considered in order to minimize taxation issues. Businesses that are "gifted" often face the issue of how to raise funds to pay the estate taxes, which become due nine months after the decedent's death. Additionally, many family businesses have open lines of credit or bank loans that are available as a safety net to float day to day business operations during leaner times. Upon the death or disability of the owner, lending institutions have the option to "call the note" in full. Careful liquidity planning should be done to cover such costs.

If available assets and or life insurance proceeds do not cover the required taxes, the IRS does have provisions in their Internal Revenue Code to allow alternatives in the payment of estate taxes, and thus owners may be able to avoid a forced sale of their business. Sections 6166 and Section 303 (for corporations) provide statutory relief for qualifying businesses. These sections delineate installment plans, along with favorable interest, that are available.

Additionally, a review of the company's existing insurance policies should take place. In a situation where the owner suffers a long-term disability, many insurance companies offer individual plans as well as group disability plans that can be activated. This provision guarantees monetary benefits to the previous owner and protects business assets from being used for such expenses. Care must be taken when setting up this arrangement.

Many CEOs are also considered "employees" of their company, and although they may also take stock option incentives, they are primarily paid as a wage earner. If disability insurance premiums are paid by the employer, payments received by the employee are considered taxable. If they are paid directly by the employee, they are shielded from tax.

In sum, there are a number of issues to consider when deciding on the right business succession plan for your company. An attorney with experience in business succession planning can help to clarify these issues and provide guidance as to the issues facing every business.