Succession Planning

What will happen to your business
after you’re no longer able to or lack the desire to run it?

 

Do you have a plan for this eventuality?

One of the biggest challenges a closely held business faces is that of succession. For a family owned business, these challenges are different than the ones that a non-family owned business will need to address. 

In a family owned business, many times the ownership is intended to pass down between the generations. While most family businesses believe that this solves their succession issues, it does not. Our experience in dealing with successful family businesses is that the ones who have a formal plan mapped out are the ones that manage this transition in a successful manner.
Issues that should be addressed include:
 

  • Who will be making decisions, what every family members’ role and responsibilities will be, and how compensation and dividends will be handled. 

  • Decide these matters prior to the figurehead leaving the business. Well thought out decisions can be made, leaving the business a framework to follow when the figurehead eventually departs. 

  • The process of mapping out what will happen when the figurehead departs will not solve all of the succession issues. 

  • If ownership of the business is in the figureheads name then the business and family risk exposure to the estate tax. This could lead to a tax equal to 45% of the business’ fair market value should the figurehead die.

  • Steps can be taken to restructure ownership to shield the business from the estate tax without taking the deciding authority from the figurehead (i.e. the figurehead retains the majority of voting rights while the stock is transferred to the heirs or to a trust).

No Real Successors

 

In businesses that do not have built in successors, the challenge of succession planning can be more difficult. The typical decision that needs to be made is that of who will buy the business. Sometimes the business is sold to insiders (i.e. existing employees) and other times external purchasers. In both cases, a fair market value will need to be established for the business. Our experience is that the value of the business is higher in cases where sound processes are in place and documented. Time is also a significant consideration; if the figurehead is sick or has passed away, the fair market value of the business will be much lower than if that person is alive and able to participate in the transition. 

As the seller of a business, the terms can have a significant effect on the amount of tax to which the sale will be subjected. Issues, such as the allocation of the sale proceeds between goodwill, equipment, building, and land, can have a dramatic effect (between 20% – 39% difference) on the taxes due to the transaction. As the seller, you may be able to defer the payment of tax under an installment sale; however, that delay also raises the risk that you face of default (i.e. not getting paid by the buyer).

Where We Can Help

 
Succession is something that every business has to consider. The best thing that any business owner or leader can do is to start planning and start having a discussion about what will happen when owners or leaders need to change. At garvey & garvey LLC CPAs, we can help with that discussion and plan. Contact us if you are interested in a free no obligation consultation.