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Business Succession Planning – The Process


Proper succession planning can often mean the difference between the success or failure of a business following the retirement, incapacity, or death of the business’ founder. Yet, many businesses have not undertaken any efforts to implement a proper succession plan. This is often due to a business owner not wanting to think about his/her own mortality. However, just as frequent of a hindrance is the uncertainty of the business owner regarding what succession planning is and how to go about implementing it.

This is the first in a three part series of articles attempting to eliminate this uncertainty by outlining the succession planning process and some tools that can be used in implementing a viable succession plan. This first article will provide a high-level overview of the succession planning process; the second article will outline some foundational aspects of succession planning; and the third article will provide an overview of buy-sell arrangements.

The first step in implementing a proper succession plan is to determine the facts, including identification of the relevant parties and the objectives of the business owner. This fact gathering is important so that the advisor can become familiar with the potentially interested parties, the nuances of the relationships between the key players, and the particular skills, personalities, and goals of those involved. Additionally, timing of a potential transition can play a key role in determining the structure and tools to be used.

Furthermore, the planning ultimately implemented will depend on the objectives of the business owner. Some common objectives include the following:

1. Stability

2. Continued control of the patriarch / matriarch

3. Orderly provisions for transition of ownership and management

4. Creation of a "market" for business interests / estate liquidity

5. Providing "equally" for children

6. Minimization or elimination of adverse tax consequences

7. Preservation of cash flow to the patriarch / matriarch

While the first step is still under way, the second step of "downside planning" will often be implemented. This step involves planning for an unexpected event (e.g., death of the owner) that could occur before the succession plan has been fully developed and implemented. Typically, downside planning involves creation of a "foundation" of basic estate planning documents, including an Advance Directive for health care matters, a Durable Power of Attorney for financial matters, a Last Will and Testament, and a Revocable Trust. Part two of this three-part series will provide further details regarding these basic estate planning documents and how they provide a foundation for the overall succession plan.

Once the basic documents are in place, and the objectives of the parties have been established, a more involved discussion of the two key components of succession planning - i.e., management succession and ownership succession - can begin. Management succession planning involves overseeing the successful transition of day-to-day management from current managers to the successor managers. Ownership succession planning involves overseeing the transfer of ownership of the business from the current owner(s) to the next generation of owners. Sometimes, the successor manager(s) and the successor owner(s) may be different individuals. However, it is critical that both of these components be addressed to allow for successful transition of the business.

Management succession planning is accomplished by engaging in a productive dialogue between family members and key employees to determine help transition the "know-how" behind running the business. Identification of the next generation of managers and beginning to equip them with the knowledge necessary to successfully run the business is critical to the success of the business. For example, teaching the successor manager how to properly price and conduct a profitable business, and introducing him or her to key relationships can be one of the most important steps taken by the existing owners. Moreover, beginning discussions regarding management succession often has the added benefit of getting the next generation more invested in the business and involved in trying to make it better.

Ownership succession planning is accomplished by identifying the successor owner or owners, and determining how best to transition ownership to them over time or upon the occurrence of a specific event. Several key questions must be resolved to successfully implement an ownership succession plan. Is the successor owner another current owner, a family member of the existing owner, or perhaps some other third party? Should the ownership be passed via gift/inheritance or should it be purchased, and if so, for how much and pursuant to what terms? Furthermore, it may be necessary to implement a funding mechanism such as life insurance to allow for payment of the purchase price. After some of these questions have been answered, the parties will then be in a position to implement a formal buy-sell agreement that outlines the rights and obligations of the parties related to ownership of the business. Part three of this article series will address buy-sell agreements and how they are commonly used in a succession plan.

After a management succession plan and buy-sell agreement have been put in place, the parties will need to undertake periodic reviews of the planning to make sure it still meets their objectives as time goes by, and to reflect any changes to the business or the parties involved. As with all stages of the succession planning process, the business owner’s team of advisors (i.e., attorney, accountant, insurance advisor, investment advisor, banker, and others) can all play a critical role in monitoring the business succession plan and implementing any necessary changes.

by Alex J. Wolf and Clark R. Youngman

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