Business Succession

"[...]business succession planning is key to protecting your company, your family and your employees against monetary burden that could leave your business in financial and legal ruins. For example, if you plan to turn over your business to your children, you have to think about the heavy gift taxes they will face. If you die, your heirs can suffer an equally prohibitive estate tax." Stephanie M. Smith, Senior Legal Advisor, USDA Rural Development

One way to continue a business is by passing it on to a new "successor", often a family member, rather than selling. However, business succession still needs to be well planned and thought out prior to a change in owners.

As current owner of the business you must ensure that your successor is well-equipped to manage the business, ready to manage the business, will be financially stable, and has all the appropriate documentation completed.
Businesses may be re-worked into employee-owned or cooperative based business during a succession. This too requires a thought out planning process and appropriate legal documentation.
While business succession planning can occur after an owner retires (or passes away) having a business plan before can help smooth the process and release possible financial difficulties (i.e. taxation and debt).

Choosing a Successor:

In some cases choosing a successor is simply picking the next family member in line or your assistant, but this is not always the case. In businesses where there are several owners (cooperatives), picking a successor means you must weigh all advantages and disadvantages. These include: position in current business, past history with business, leadership capability, and how others will feel.

Having a Business Succession Plan:

Creating a business successor plan will help smooth out operations once the event will occur. This allows owners, partners, potential successors, etc. the opportunity to discuss financial and managerial aspects prior to business succession. It will also allow for timely settlement of previous owner's estate and more readily-available policy benefits.

Critical issues to consider:

1) Valuation

No matter who inherits your business, it is critical that you get an accurate valuation of your business. Such a valuation encompasses tangible assets such as:

Real estate & buildings
Machinery & equipment
Employee loyalty
Manufacturing processes
Customer base & business reputation
Patents on products & new technologies.

A business valuation is also a way to predict your company's future. Using your firm's historical and financial records and your judgment as owner, work with your valuation firm to calculate whether your business will grow or decline, future inflation rates and anticipated costs and expenses of running the operation.

business succession

2) Ownership and control

A family owned business is often held and controlled by husband, wife (or both), or a number of siblings. Other, non-family, closely held businesses often have a more complicated system of ownership and control. Along with ownership comes control over compensation, benefits, hiring/firing, management and short- and long-term business goals.

3) Management Succession

A family business must be viewed in terms of the way in which management decisions are made for non-family businesses. Non-family businesses make decisions according to performance of their employees and reward them accordingly. Overall, the relative strengths and weaknesses of the family members must be carefully considered in determining the management restructuring that must take place.
This means owners need to consider:

Identifying & training appropriate family members to be the successors
Identifying non-family members as successors if they prove to be the key people to ensuring the sustainability of the business
Appointing short-term successors while long-term successors complete the necessary training

4) Tax Planning

The cash-flow consequences of succession planning are crucial to success. This is an area where the team approach of professionals can really bring value to the process. In the area of estate and gift taxes, questions need to be raised regarding lifetime transfers or transfers at death

Should there be carry over basis gifting) or stepped up basis (transfers at death)?
What will be the death tax cost to transfer the business and how will finances be arranged to meet the obligations?
In the area of income tax planning, what will the capital gains be if the entity is sold to outside parties?
Are there ways that this gain can be deferred or eliminated, perhaps with charitable tax planning?
What income will the retiring owners need, and what income levels will successors expect in their new roles?

These questions should be answered by competent legal and accounting professionals who work with estate and tax planning issues. Material adapted from: Stephanie M. Smith, USDA Rural Development "Legal Corner"