You might have had help building the business you own into the success that it has become. Or, you might have accomplished it all primarily on your own.
But whatever the case, now that it’s time to retire or otherwise move on and turn over control to a successor or successors, you’re going to want to use a team approach. It helps to have professionals who specialize in succession planning working closely by your side, local legal advisers say.
“A team is highly recommended,” said Grand Blanc business and estate planning attorney Christine Waun.”There are both tax and nontax considerations in every transaction and working with professionals will help minimize problems down the road.”
According to Waun, you should look for professionals who are experienced and knowledgeable in the areas of business succession planning and related tax issues. These issues can range from how to minimize tax to the seller to how to properly report a gift of stock to the IRS.
The typical team would consist of an independent qualified business appraiser who can tell you how much your company is worth, a certified public accountant who can provide guidance on tax implications and an attorney who is knowledgeable about tax and other legal matters and can expertly draft the sale documents.
Francine Cullari, a Grand Blanc Township attorney and lecturer at the University of Michigan-Flint’s School of Management, said that owners often do not want to deal with their withdrawal from the business or death.
“Failure to plan can affect success and taxation,” said Cullari, who is also former director of the Michigan Family Business Center at UM-Flint. “Succession planning should be seen as a journey, not a one-time event.”
While the specifics of each situation are different, here are a few broad considerations that a team of succession planning experts can help business owners address as they’re planning their exit:
Decide who will take over the business. “Succession planning is transitioning a business, which may involve transferring ownership or replacing key employees,” Waun said.
Depending on the type of business, it may be continued by a family member or members; a business partner; a longtime, integral employee; or an unrelated third party. “There are different ways to structure it, depending on who’s going to take over the business.”
Keeping it in the family. When preparing to pass down a business to one or more heirs, you need to answer several hard questions, Cullari said. Among them, she noted:
- Are the heirs qualified to lead the business? Have they had adequate education, training and experience? Will it be valuable to plan to include professionals as managers and/or as directors?
- If there’s more than one heir, will they have an equal interest, equal management control, equal distribution of profits, equal liability?
- Is there sibling rivalry that will come into play if more than one heir is in leadership positions?
- What if heirs who own business have disparate goals (growth vs. status quo vs. sale of business)?
- Are the heirs creditworthy if an infusion of funds is desirable?
Another consideration is whether interests are to be given or sold to heirs in stages. “Their behavior as owners can predict future success of the business,” Cullari said.
Tax talk. “Succession planning can have some practical implications from an estate tax planning standpoint,” Waun said.
For example, consider an owner who doesn’t do any estate planning beyond leaving the business for his or her offspring to inherit. Chances are the business is the biggest asset in the estate. Since it’s also likely an illiquid asset, the inheritors may have to come up with cash quickly to pay the estate tax that is due in nine months after the owner’s death, Waun said.
That looming tax obligation could result in the heirs having to liquidate the business or sell it at a deep discount, she said.
Gifting is one method for transferring ownership while minimizing estate taxes. One of Waun’s clients owns income-producing commercial real estate properties through various limited liability companies that he is methodically gifting interests in to his children while he still manages and controls them. The gifting strategy reduces the taxable value of his estate while also providing an income stream to his heirs.
An alternative approach would involve gifting cash to the heirs that they could in turn use to buy stakes in the business.
Buying out partners. If there are other owners of a business, buy-sell agreements are commonly used to indicate what happens if one owner wants to retire or passes away. In the case of a death, life insurance is usually in place for the partners to use to purchase the deceased owner’s interest while also providing cash to the former owner’s estate, such as a surviving spouse, Waun said.
Timing. While succession planning is probably not top of mind for owners of startup businesses, it’s a necessity when the operator of an established company is looking toward retirement.
For example, it’s advisable for a physician who’s thinking of retiring in three to five years to start the process soon, Waun said.
“They’re going to have to find a buyer — which could involve another physician or practice or possibly private equity – negotiate terms, draft documents and close the transaction,” she said. “It takes time to put all of that in place.”
Psychological preparation. Sellers also need to prepare themselves psychologically. Sales terms often require the seller to work as an employee or consultant of the business for a couple of years to smooth the transition.
“If owners continue to be involved in the business, can they be flexible enough to accept new ideas from a younger generation?” Cullari asked.
Waun echoed those concerns. “It’s hard oftentimes for the owner because they’re ceding control of all the decisions and now they’re an employee of the business. From a mental standpoint, it’s often difficult for them to make that transition.”
Retiring business owners also should ensure they have a purpose or focus once they are fully done working, she said.
“A lot of times what happens is the business owner is accustomed to going into the office full time, and then they sell and have nothing to replace that routine,” Waun said. “Things like hobbies or other interests will help maintain a sense of purpose.”