The Importance of Business Succession Planning for Small Business Owners
December 14, 2011
by N. Craig Hathaway & Jack Brusewitz
Small businesses have been the engine behind America’s economy. With more than 10 million small businesses in this country, many business owners have decisions they need to make in order to provide continuity for their businesses. These owners have many tools available in order to provide an orderly and cost-effective transfer of their business.
The tools that are chosen by the small business owner depend upon the ultimate goals and objectives that the owner desires. It depends upon whether the owner is planning on working forever, and therefore transitioning the business upon death or disability, or whether the owner wants to retire from the business and reap the financial rewards of transitioning the business while living.
The problem that most small business owners have is that they are so busy running the company day-to-day, that they don’t take the time out of their busy schedule to do the proper planning. With planning, the odds are much greater that the business will continue to provide for the owner and the owner’s family, as well as employees and customers.
If the business owner dies without having completed business continuation planning, many potential problems can surface:
1. Heated conflicts can result among not only the remaining owners, but the decedent’s family.
2. Unhappiness on all sides and potential litigation.
3. Delays in settling the estate.
4. Obstacles for continuing business growth.
5. Loss of customers.
6. Possible liquidation of the business at less than fair market value.
At death or disability, no asset tends to deteriorate as quickly or completely as a small business. The drop in value can be astounding without planning.
Think about it. If a friend owned a car or a home or almost any other tangible asset, one month after that friend died, the value of the car or home would be relatively the same. But if the friend owned a restaurant that didn’t open for a month, or a manufacturing plant that produced no goods for a month, what would the business be worth at the end of that month?
Taking the time now to see that the business will pass in an orderly manner upon death or disability will benefit all parties and their heirs. A written agreement can provide:
1. An orderly transfer of the business.
2. A mutually agreeable sale price.
3. Mutually agreeable terms of the sale.
4. A value that is binding on the IRS for federal estate tax purposes.
5. Stability for customers, employees, creditors and investors.
Many times there are competing interests between the owner’s heirs and the surviving owners of the business. The heirs are looking for the top dollar from the business, while the new owners want the minimum cost for the business interest. The heirs want a prompt settlement of the estate, while the owners want the business interest promptly transferred. The heirs want a set value of the business for estate tax purposes. The owners want full control of the business with no interference from the decedent’s family. The family wants relief of worries regarding the business and its creditors. The owners want a continuing line of credit without outstanding debts to the deceased owner’s family.
An agreement which is favorable to all parties can be more easily drafted prior to a crisis triggering event. It will answer questions such as: Where will the money come from to buy out the deceased owner’s share? How does the business stay liquid with operating capital while at the same time paying any liabilities or taxes created at the owner’s death?
If the business owner wants to sell the business and retire, it is imperative that the owner prepares his game-plan well in advance of the anticipated sale. This will allow the owner to receive fair market value for the business, as well as having proceeds from the sale being received in a way that corresponds to the financial needs of the retired owner. A continuation plan prepared in advance also allows the owner to structure the sale so it can be tax-efficient. The owner can then understand the full tax ramifications of the sale.
All buy-sell agreements should be carefully coordinated with the owner’s estate planning goals. There are many estate planning strategies that can complement the sale of the business and allow the transaction to be more income and estate tax effective.
Such strategies include:
1. Family Limited Partnerships.
2. Private Annuities.
3. Grantor Retained Annuity Trusts.
4. Self-Canceling Installment Notes.
5. Other techniques that would be dictated by the owner’s goals.
The business owner should select qualified advisors to help set up the plan that will fulfill the owner’s goals. Many of these questions can be answered through the proper use of life insurance, annuities, and disability insurance, along with properly drafted legal documents and a solid business valuation. A team consisting of an attorney, accountant, insurance agent and financial planner can help ensure that the decisions the owner makes are legally and affordably meeting the owner’s needs.
N. Craig Hathaway is the President of Advanced Insurance Solutions Agency, LLC. (AisA) He is a business, estate and life insurance consultant and conducts seminars with attorneys and accountants on business continuation, executive benefits and wealth transfer planning.
Jack Brusewitz is with Leonard & Company. Leonard & Company is Michigan’s largest independent brokerage firm, with its headquarters in Troy and several offices across the state of Michigan.
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