Business succession plans essential for long-term success

While most professionals think about eventual retirement, planning for the future is different for people who own their own businesses.

Having a plan in place in case an owner retires, dies or becomes disabled is important if the end goal is for the company to continue operations.

When it comes to deciding just when to put a plan in place, there's no simple answer, according to Bill Woody of Stovall-Woody Associates, a financial planning consulting firm.

"It varies a lot. Certainly (it's time) if he's been in business at least five years and is successful. Certainly if he has a large amount of debt at any time, and certainly if he has family that he cares about," Woody said. "What we do, and what we suggest most people should do, is spend quite a bit of time developing where the business owner is and what they really want."

For business owners to determine what they want is more challenging than it sounds, Woody said, because "a lot of times they're so busy with the day-to-day minutiae of business that (they) don't take the time to think about some important things."

How the death of the owner will affect a company is one of those things, Woody noted, but it's also important to think about what will happen when the owner retires or if the owner is unexpectedly disabled.

Using the one-size-fits-all approach isn't a good idea in terms of succession planning.

"If somebody comes up with a cut-and-dried answer, they're not doing a good job, because you have unique situations in almost every case," Woody said.

Attorney Glenn Green with Lowther Johnson Attorneys at Law said all companies should plan for the future, but he added that succession planning is most important for companies that have a sole owner or that have a small number of key people running the company.

"Obviously, if they're the sole person, the business is going to tend to die with them unless they have some arrangements made, whether it's having succession planning in place for a relative to come in, or whether they have an agreement with an employee or some employees to come in and take over and pay the estate or the heirs a certain fair value for the business and take it over," Green said.

Companies that have multiple key people driving the business also can have problems without a plan in place.

"A lot of times when you have multiple members that are the key people, unless you have succession planning in place, you can end up with the remaining survivors having to do business with the spouse or the children or the other heirs of the deceased partner and that can make for an uncomfortable situation, because a lot of times there's not a lot of knowledge on the part of the heirs about how the business runs, yet the other partners have to allow them to vote, have a say, in the different directions that the company may go," Green said.

And thinking about future events is essential for the company to survive, he added.

"If you have an incapacity that may be a lengthy period of time, then that does become an important situation, because you make sure things are set up so the company can run effectively without them, so that somebody is empowered to make decisions and conduct certain actions, absent the incapacitated owner's approval, whether that's set up in the succession plan of the business, or in conjunction with some durable powers of attorney," Green said.

Options

A simple solution is to put a plan in place that maps out who will step in if the business owner is unable to perform his or her duties.

"Let's suppose you have a business owner who doesn't have any family in the business, and you can construct a situation for key employees to be able to continue the business, and either A) buy out the family's interest, or B) provide the family with some money and continuing the family's involvement," Woody said. "Sometimes you get some very complex situations if you have a bigger business that has several different parts and you may want to set up a provision where you have multiple succession plans."

Other options include involving a competitor in the same industry for a merger or a buyout.

"If you have a child or children who can and want to be involved in the businesses, then you make sure the finances are there, that the children have the abilities and the counsel from other people to help them run the business," Woody said. If there are other children who won't be involved in the business, Woody added, then it's important to equalize interests.

"Sometimes you get into multiple family situations, and it can be very complex, especially in today's world, a lot of these children become divorced and the prior spouse issue complicates things in some of the planning," Woody said.

Choosing a family member to step in and run a business once the owner is out of the picture for whatever reason should be done very carefully, Green said.

"One of the main (mistakes) that I've seen is simply people having provisions that the heirs of the deceased owner take over their ownership interest, without giving a thought as to whether those people are competent to take over, have the desire to take over, have the time to take over, whether they can work effectively with the remaining owners," Green said. "Sometimes, people tend to judge their relatives or their heirs in a more favorable light and don't realize what it might be like to try to get along with them in a business."

Woody agrees that unqualified or uninterested family members can be problematic. "Sometimes, they're good enough to make it work. Sometimes, they simply drive the business into the ground," Woody said.

Another key issue for succession plans that involve the buying out of the deceased or retiring owner's interest is how that buyout would be funded.

"Absent a specific provision that would allow payment over time, then they would need to be paying that shortly after the party was deceased. And then you have a situation where either they're trying to go out and borrow the money which may not be very easy when the purpose of the borrowing is only to buy out a member's interest to its heirs or you simply do not have the cash in hand or the cash flow available to make any substantive payments that would be of any size," Green said.

Life insurance coverage can be a good tool for making financial provisions upon an owner's death, "so that you're buying out the person's estate or however they have it held, with life insurance proceeds," said CPA Bill Miller of Kirkpatrick, Phillips & Miller, CPAs, PC.

"Depending how the buy-sell agreement is written, you either have a cross-purchase agreement where there may be individual owners with life insurance to buy the other person out, or it's a redemption type, where the company owns the insurance and redeems the person out," Miller said.

Another choice, according to Woody, is a sinking fund.

"A sinking fund is if you've got a lot of cash and you invest X' number of dollars in an investment perhaps in another company, in a mutual fund, in a stock and then some of that money can be used to fund it," Woody said.

Disability buyouts are a situation in which adequate funding also is important, but is often overlooked in planning.

"When those happen and for younger ages, the probability for long-term disability is higher than it is for death in the immediate future then you need to address that and put in place disability policies that will buy out a business, either in a lump sum or in three to five years, and get the disabled person out of the business and let the successors function and run the business," Woody said.

Plans can be flexible enough to allow a disabled owner to return to work once recovery is complete.

Woody noted that succession planning should be a team effort among attorneys, financial planners and CPAs.

Knowing a business, its owner and its management well is important, Miller added.

"Where I come into play is along the lines of entity structure helping entities structure with the tax implications of the succession plan," Miller said. Simply put, the CPA's role in succession planning is " really to make sure that they're not shooting themselves in the foot from a tax standpoint.

Tax implications differ for different parties.

"Because whenever you have the tax implications on the person that's disposing of the business, versus the tax implications of the person acquiring, sometimes, there are conflicting issues there," Miller said.

His role, he said, is providing the best solution for all of the parties involved.

Retirement

While individuals can't foresee death and debilitating events, retirement can be planned. Woody said it's important for business owners to recognize when it's the right time to go.

"A lot of people, if they are in business (and) don't have a succession plan where they can go out at their retirement, then sometimes they stay on too long," Woody said.

"One of the nice things about business today is that if you want and continue to be active to 75 or 80 but these people typically change the way they do business. Their bowing out gracefully at a time that works for everyone else is important, too.

And, he noted, business owners shouldn't have to worry a lot about succession planning once a plan for action is put into place.

"On your planning for succession, you need to devote some time to it intensively to develop your long-term strategy, and then go on to other things where you don't have to think about it every day, you don't worry about it every day," Woody said.