3 Essential Steps to Business Succession Planning – Part 3

Design an Estate Plan to Transition Ownership of the Business

Business plan meeting

You are beginning to think about retirement. You have been actively involved in building your business for years and have seen its continued success. You may have a child in the business, or you may have certain employees who want to take over. Perhaps you have neither and are wondering who might want to buy the business. You have heard of an ESOP, but don’t really know what it is or how it works. Your spouse is not involved in the business, but you want to provide for your spouse should you die unexpectedly or become disabled.

This is a common scenario faced by many business owners. How do you leverage the years of hard work you have invested in building a successful business to ensure it continues to flourish through a transfer of leadership to the next generation? Further complications can occur when you wish to transition the business to a child who is actively involved but also maintain proportionate distributions to your other children who are not in the business.

A successful transfer requires intricate planning. Failure to properly plan for a smooth succession during your lifetime can result in monetary losses, lasting damage in family relationships, higher taxes, and even loss of the business itself.

Estate planning is an essential component of the succession planning process. The goal of estate planning is to ensure your loved ones are cared for after you are gone and to provide for the management and transfer of your assets including your business, in the event of your death or incapacity, at the smallest financial and emotional cost to your family. Business succession planning integrates estate planning techniques to position the business for continued success when the owner retires or dies unexpectedly.

This article will address the three essential steps to developing a business succession plan.

  1. Define your long-term personal and business goals.
  2. Develop a management plan for the business.
  3. Design an estate plan to transition ownership of the business that meets your goals.

In this article, we focus on the third step in the process.

STEP THREE:  Design An Estate Plan To Transition Ownership Of The Business That Meets Your Goals

A major concern for business owners with children who are active in the business is how to treat all the children equally in the business succession process. The situation is further complicated when business owners lack sufficient non-business assets to allow them to leave an equal share of their estate to the children who are not active in the business. Developing the appropriate estate plan is crucial in addressing these concerns.

Selling (as opposed to gifting) the business to the active children may be one option to provide an equal distribution among all the children. The sale price may be at fair market value determined by an independent appraisal. Typically, the purchase price will be paid in installments with interest over a term of years.

Another option may be to gift the business to the active child and leave non-business assets to the other children. Essentially, the other children would receive an equalizing distribution of other assets to provide a “fair and equitable distribution” for all. If non-business assets are insufficient to provide a “fair and equitable distribution” to the other children, you may consider making up the difference by purchasing life insurance and holding that insurance in an irrevocable trust for the benefit of the other children.

If the active child has played a key role in the success of the business, then you may feel it is fair to acknowledge the time and dedication he or she has devoted to the business through lifetime gifts of business interests (as opposed to selling the business) or through a larger portion of your estate in the form of the business interests compared to the other children. Or perhaps you lock in a valuation for that active child so that he or she gets the benefit of the future growth driven by his or her efforts. Keep in mind that in some cases, fair may not always be equal.

Instead of distributing the business interests outright to your active child, you may consider keeping such interests in trust. Establishing a dynasty trust will keep the business interests in the bloodline for your child’s lifetime and then upon your child’s death, to your grandchildren and other successive generations. A dynasty trust also will protect your child and your grandchildren from outside influences such as creditors, a divorcing spouse, or the premature death of your child. It may go without saying that you do not want your child’s divorcing spouse or a new spouse, if there is a premature death of your child, owning a piece of your business!

An essential part of designing your estate plan for business succession purposes is to minimize gift and estate taxes. In 2017, an individual may transfer $5.49 million free of federal estate and gift taxes. Married couples can protect almost $11 million of their estate from federal estate and gift taxes. Factors to consider in determining what estate planning techniques to use may include the size of your taxable estate, your need for retirement income, your desire to control the business during the succession period, and the desire to treat your children (both active and inactive in the business) fairly and equitably.

In combination with your estate plan, the successor owner of your business should enter into a buy-sell or shareholder agreement with the other owners, which is a legal arrangement providing for the redistribution of shares of the business following a triggering event (i.e., an owner’s death, disability, retirement, legal proceeding or termination of employment). The buy-sell agreement sets forth the purchase price and payment terms upon the triggering event. Life insurance is one way to provide the cash necessary for the business or surviving owners to purchase a departing owner’s interest.

Business succession planning is a very complex process, but a sound business succession plan is an investment that will pay off for you and your heirs for generations to come. An estate plan that aligns with the goals of your business plan and is tailored to meet your personal and unique objectives and financial situation is an important component of the overall process.

It is essential to surround yourself with a team of advisors to assist in the planning process. Each professional brings to the table a distinct skill set that is necessary to design and implement a plan for you and your family that will enable you to reach your goals. Planning for the future is difficult and filled with unknowns, but instead of worrying about what cannot be controlled, find power in planning for that which you can control.

Read additional articles in our Business Succession Planning series:

Pittsburgh Business Succession Planning Attorney

Dan Lynch routinely helps business owners with the transition of their business. Please contact Dan if you have questions about this process. You can reach him by calling (724) 776-8000 or via email at dlynch@lynchlaw-group.com.

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