Make Your Succession Plan a Plan to Succeed
When siblings Mike and Amy started a cleaning service business as equal owners 30 years ago, they started out small — cleaning a local office or two. Over the years they added employees and commercial clients, including Mike’s two sons and Amy’s three daughters.
Mike died unexpectedly; and the business floundered. Did Mike’s widow, who had no interest in running the business, inherit his share? Who was in charge? Where did their children fit in?
Every entrepreneur who starts a business should write a plan to succeed. They often overlook the need for a well-thought out succession plan. Who will carry on their dream when they cannot?
Two compelling forces often pull on business founders. Their business creation — their baby — can pull them one way. Their children’s desires and abilities as successors may pull them another way. These forces ignite strong emotions.
A succession plan considers the future. It sets a plan for how to carry on the business with minimal acrimony and transfer value to a second generation (if that is the objective) at the least possible tax cost. The plan recognizes that poor choices could lead to financially devastating results.
To begin, all owners forge an agreement on business objectives. They should address the “what-ifs” such as incompatibility, disability, retirement or death. Then they put those objectives in writing in a “buy-sell” agreement: an agreement either between a business and an owner, or the owners — or both.
Consider two types of “buy-sell” agreements:
- A redemption agreement. The business agrees to buy the owner’s interest upon a “triggering event” such as that owner’s death.
- A cross-purchase agreement. The owners agree to buy the share of another owner upon a triggering event.
Both agreements usually address conditions which trigger a buy-out, as well as the price and payment terms.
Next, all the owners should review the feasibility of funding the agreement with life insurance if the death is the “triggering event” — to pay off the deceased owner’s shares. In case of other triggering events, such as retirement, does the business (or other owners) borrow money? Are they able to internally finance the purchase? Make sure all the owners’ personal objectives and their wills and trusts are coordinated accordingly.
Advice to owners: Don’t tackle it yourself. This is an emotionally and legally complex area of law — seek counsel from a qualified estate or business planning attorney. If a business is to survive into a second and third generation of leadership, it needs a succession plan to succeed.