Succession Planning Two Ways: Business Items And Emotional Items

All experts agree that looking at succession planning sooner rather than later is the first step for a successful transition from one generation to the next. The reasons to start succession planning early are abundant: Most family businesses don’t survive from one generation to the next, the unexpected death of the business owner can plunge the family into emotional and financial despair, and the impact from estate taxes can be enormous.

There are two separate areas that need to be addressed when succession planning: The emotional items—if there are family members involved in the business, they must decide who is best suited to take over the business; and the business items—estate taxes, life insurance and buy-sell agreements.

The business items are often easier for owners to deal with, so let’s start with those.

Business Items

If enough time is allowed for succession planning, there are many techniques that can be used to transfer the family-owned business to the next generation while minimizing or eliminating the gift or estate tax. Family limited partnerships, grantor retained annuity trusts (GRATs) and a sale to an intentionally defective grantor trust (IDGT) are three commonly used techniques to transfer from one generation to the next. These techniques can be used independently or in conjunction with one another to provide asset transfer options to the business owner. These techniques are used to “freeze” the value of the business, even at discounted values to the business owner’s estate, and transfer all of the appreciation in the business to the next generation. This lowers the value reported in the estate and thus creates a smaller estate tax burden.

Even if estate taxes are owed, they may be spread out over many years when the tax involves a family or closely held business. If taxes can be spread out, this may enable the family business to survive being liquidated to pay the estate tax.

Life insurance is usually an important component to a succession plan. It can be used to pay for estate taxes if an owner dies unexpectedly. It is important that the correct policy be purchased so it will be effectively used. Another popular use of life insurance is to equalize the distribution from the estate to the children that aren’t involved in the business. Most families want to treat the children equally, and this becomes difficult when the business assets are worth more than other assets. Also, another use for the life insurance is to fund a buy-sell agreement.

A buy-sell agreement normally spells out the stipulations for a buyout of the owner’s interest upon retirement, death or incapacitation. These agreements are important because they dictate who will purchase the business and how the business is to be purchased. Without a buy-sell agreement, the stock in the business might end up going to an heir that might not be a desirable business partner. A buy-sell agreement should cover the valuation of the business, the source of proceeds for the buyout and various other provisions. It is important to remember that this valuation is not necessarily binding for estate tax purposes, even if binding for buyout purposes.

When talking about estate freezes and buy-sell agreements, the valuation becomes important. It is critical that someone skilled in business valuations be used to determine the value of the business. A good business valuation can serve to support the estate tax value, as well as provide a starting point for the buy-sell agreement.

Emotional Items

While business owners often acknowledge the financial and tax implications of passing on their company in the event of their death or retirement, few understand how not planning emotionally can take a toll on their loved ones. If management and chain of command issues are dealt with early, it can save a family from tearing itself apart over the business.

Business owners need to take a hard look at who will be running the business after they leave. Sometimes it is one family member, sometimes several family members and sometimes a mix of family and non-family members. If a good, strong and capable business leader isn’t among your family members, you may be facing one of the most difficult decisions a family business owner can make—taking ownership outside the family. Sometimes selling the business might be the best decision.
However, if keeping the business in the family is viable, the best way to deal with succession and ownership issues is to have a formal meeting with family members, and likely, an impartial mediator. Family members who won’t be a part of the day-to-day operations can always be involved on a board of directors or can be cared for through other financial arrangements, such as life insurance.

Ideally, if you start succession planning early enough, many pitfalls can be avoided as people involved will be able to clearly see the direction the company is headed. As retirement approaches, business owners need to prepare themselves for handing over the reigns. If they have built the company from the ground up, letting go might be harder than expected.

Larry Powell and John Venturella are shareholders in the Middletown office of Clark, Schaefer, Hackett & Co. For more information from the company, visit www.cshco.com.