The Basics of Business Succession Planning

Business succession planning is a comprehensive strategy for transitioning a business from the current CEO or managing partners to a successive generation. Established, family-owned businesses often require a sound succession plan in order to ensure a tax favorable transfer of ownership. Because of hefty capital gains and estate tax implications, having a prearranged restructuring plan makes certain that the baton is passed to the successors with minimal disruption to the business.

A number of concerns arise regarding the succession of a business; a question of ownership is likely the most immediate of these concerns. Due to a death or a disability of the key operating person, who is oftentimes the original founder or owner, issues regarding the direction and control of the business must be settled. Family members may suddenly be put into a stewardship role, forced to make key decisions regarding continuing the business or liquidating it. While many business owners may have a vague notion of a desire to pass on the business to their heritage, they may have given little thought to the legal implications of doing so.

A chain of command should be outlined while the head of the business is still an active participant. That may involve the passing of the business to family members, or another handpicked successor. When two or more children are involved in the family business, care must be taken so that all family members have a clear understanding as to the succession of ownership. This grants assurance that the business continues to operate efficiently and profitably, and avoids disruptive disputes that may arise later.

Other topics that need to be addressed in business succession involve retirement planning, the transferring of assets to the heirs, and of course, navigating the tax code to arrive at a favorable financial outcome.

A review of the company's and executive's existing insurance policies should be done. In a situation where the owner suffers a long-term disability, many insurance companies offer individual plans as well as group disability plans that can be activated. This provision guarantees monetary benefits to the previous owner and protects business assets from being used for such expenses.

Care must be taken when setting up this arrangement. Many CEOs are also considered "employees" of the company, and although they may also take stock option incentives, they are paid as a wage earner. If disability insurance premiums are paid by the employer, payments received by the employee are considered taxable. If they are paid directly by the employee, they are shielded from tax.

Life insurance policies can also serve as a fund from which children who are not involved in the business succession can be compensated. If these policies are purchased early on, when the existing owner is young, they are less costly to maintain.

The method used to formally pass the ownership of a business may differ. A Buy-Sell agreement can be used to sell the establishment to employees, family members, or interested outside business owners. This agreement helps to establish an estate tax value for the business. Essentially, it is an agreement to buy and or sell the interests of the business at a predetermined price, or once an event comes to fruition, such as a death or the disability of top management. It is referred to as a buyout.

The Buy-Sell option can also be used if the family business is set up as a shareholder arrangement. Shareholders are allowed to purchase the interests of the departing shareholder at a set price. This is often called a buy-back. If a large number of shareholders are involved, another option may want to be pursued.

Retention planning is the most common tool used to keep the business, as well as its assets, in house. Asset protection must be considered so that the transferring of personal and business assets from the previous owner to the current owner are shielded from overreach of any third party, including the payment of taxes.

Businesses that are "gifted" often face the issue of how to raise funds to pay the estate taxes, which become due nine months after the decedent's death. Additionally, many family businesses have open lines of credit or bank loans that are available as a safety net to float day-to-day business operations during leaner times. Upon the death or disability of the owner, lending institutions have the option to "call the note" in full. Careful liquidity planning should be done to cover such costs.

If available assets and or life insurance proceeds do not cover the required taxes, the IRS does have provisions made in the Internal Revenue Code to allow alternatives in the payment of estate taxes and thus avoid a forced sale of the business. Sections 6166 and Section 303 (for corporations) provide statutory relief for qualifying businesses. These sections delineate installment plans, along with favorable interest, that are available.