You have a great business. Profits are up, your employees love you, you and your business partner never have a disagreement. You love your job and never want to retire. You will live another 100 years and will continue to be strong and healthy for the rest of your life. Is the picture starting to sound too rosy? The truth is, bad things happen to good people. As the saying goes, “luck favors the prepared.” Business succession planning is essential to ensure that your business transitions smoothly to the next owner(s) or to the next generation in case of death, disability, divorce, or retirement. Let’s talk about a few essential parts of a good succession plan:
How does your operating agreement (or Bylaws, if your business is formed as a corporation) deal with death, disability, divorce, and/or the sale of your business? Has anyone sat down with you to discuss these different scenarios? Many operating agreements either don’t address one or more of these items or don’t address them adequately or clearly. For example, should the company have the option of purchasing your ownership from your surviving spouse when you pass away, or should it be required to do so? How is the company’s value determined at that time? Does your operating agreement require an appraisal? Who pays for the appraisal? What happens if there is a dispute? The same questions apply to disability, but you will likely want different answers. Does your operating agreement give a first right of refusal to the company upon the divorce of one of the owners? How easy or hard will it be to sell your business at retirement? Where does the value of the company lie? The operating agreement can and should address these and other questions. If you don’t know if your operating agreement is adequate, you should have it reviewed and potentially amended by competent legal counsel.
Estate Planning Documents
Most operating agreements refer to an owner’s estate planning documents to determine succession. If an owner doesn’t have a personal or family trust, the business could be tied up in court for months or even years before ownership and/or management issues can be resolved. Delay like that could reduce or eliminate the value of a business. Be sure your estate planning documents properly and thoroughly address your business interests, and are coordinated with your operating agreement and other documents relating to the sale of your business.
If you own your business with one or more partners, a good buy-sell agreement is essential. A buy-sell agreement complements your operating agreement and discusses the specific terms for the purchase or sale of your business (through either a redemption or cross-purchase). These agreements are often funded with one or more life and/or disability insurance policies. Depending on your situation, it might be best to create a separate business entity to house the insurance policy(ies). It is important to work with a team of qualified professionals (usually an attorney, CPA, and insurance agent) to make sure a buy-sell agreement is properly structured and funded.
Any good succession plan will take taxes into consideration, especially when it comes to selling a business. Ideally, a business will be designed with the end in mind, and will make sure that a business maximizes its capital gains and minimizes taxation at ordinary income rates. Additionally, there are multiple tools that can significantly affect taxes upon the sale of all or part of a business. Be sure to speak with a qualified tax professional at least several months before you plan on selling your business or any large asset (such as real estate). A brief discussion could save you tens or even hundreds of thousands of dollars in unnecessary taxes.
This article is meant to provide general information and should not be construed to contain individual tax or legal advice.
By Jacob A. Stewart JD
See original article