With years of blood, sweat and tears poured into your small business, are you or your family in a position to reap the benefits of your hard work? With most studies showing that over 60 percent of small-business owners do not have a succession plan in place, you are certainly not alone. With so much at stake, why would so few fail to plan for the future? Whether it is the small-business owner’s entrepreneurial mindset or reluctance to think about his business surviving without the owner’s input, a succession plan should become a priority and probably sooner than anyone would ever anticipate.
Once you’ve gotten past all of the regular hang-ups of “letting go” and embracing change that we have trouble accepting, you must consider a couple things when discussing your succession plan with your advisers.
Who to sell or transition my business to and what is my business worth are probably the most important factors in any succession plan. Typically in organizations that have more than one owner, this may have been discussed and hopefully even implemented at the time of formation. You and your “partners” may have spent some time discussing and negotiating bylaws or the terms of an operating agreement for your recently formed LLC. In conjunction with that, you may have even addressed succession through the use of a cross-purchase agreement. With other owners already involved in the business, you’re halfway home. But even still, the excitement of the new venture might overshadow the need to address the succession of your business should something happen to one of the owners.
In most situations, value becomes the driving force behind all of the rest of the planning. Many business owners are reluctant to admit their business might not be nearly as valuable as they think and even more reluctant to pay for an expensive valuation. Regardless of the methodology, a firm grasp of value will begin the process and set the foundation for myriad decisions along the way. If you want to sell your business to a group of trusted employees who have been with you from the beginning and they cannot afford the purchase, you’re right back to square one.
What if your desire is to treat your three children equally in your estate plan, but there is only one child interested in taking over the business? Do the other two children become minority owners or a majority when they vote together? Is there a period their sibling can buy their interests out, or do you just give the company to the one child interested in the business and accidentally treat your children inequitably when the valuation is completed after your passing?
Complicate things even further by considering you’re not dead but simply disabled or incapable of continuing to run the business. Is your spouse now a silent partner with the other owners?
In addition to addressing whether purchases or transfers are mandatory or optional, or even creating the more sophisticated tag along, drag along or “suicide put” provisions in an agreement, the structure of the sale can have significant ramifications. Take for example an LLC or S Corp. that passes all tax attributes to the owners. In cross-purchase agreements with fellow owners, we always know the transaction will be structured as a stock or ownership interest purchase. But with an outsider, should you structure the transaction as an asset sale or sale of your ownership interest? If you sell your ownership interest, you and the buyer negotiate a price and you pay capital gains on the amount the purchase price exceeds your basis. It’s pretty straightforward. Most buyers would rather purchase the assets, allowing for the recovery of the purchase price through tax deductions as inventory is sold, real assets are depreciated or goodwill is amortized. As a seller, you must now agree with the buyer on the allocation of the purchase price among the various assets. Without considerable thought and calculation, you may inadvertently transform preferred capital gain treatment to ordinary income if the amount allocated to inventory exceeds cost of goods sold or if there is depreciation recapture.
Just like estate planning, succession planning for a business is not a one size fits all solution. With a well formulated succession plan implemented and with the advice of your counselors and advisers, you’ll be able to navigate death and disability the same way your business flourished through peaks and valleys of economic change.
Steve Kamienski is vice president and relationship manager at Central Trust Co. He can be reached at
steven.kamienski@centraltrust.net.
