Succession Planning

Succession Planning is Continuation Planning

A well-thought out succession plan is an insurance policy and is essential to the continuation of a business, no matter what its size and structure. Some of the reasons your should begin Succession Planning sooner rather than latter:

1. Serious illness, disability or death can catch a firm by surprise.
2. Brings great upheaval, both personal and to the business
3. Difficult to make rational decisions in the best interests of a company when emotions are running high

Some facts related to Succession Planning

· Ninety percent of the 21 million U.S. businesses are family-owned
· Only 30 percent of family-run companies today succeed into the second generation
· An even smaller 15 percent survive into the third
· The reason, according to many experts, is obvious: the lack of an orderly succession plan
· The toughest thing for the entrepreneur to realize is that time is constantly running out
· Most owners don’t plan because they don’t think they are ever going to retire or die.
Timing

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Owners should begin planning while they are still healthy and active in their enterprises.

· The time to plan is between the ages of 55 and 65, experts advise.
· The plan itself—should be a process, rather than a single event.
· If successor is already anointed, adequate planning time allows that individual to build up expertise so the passage transpires so gracefully that no one in the company even feels it happen
· Adequate planning time enables you to:
· Test potential successors in different roles and Evaluate their
· Maturity
· Commitment
· Business acumen and
· Leadership abilities

Planning

Begin by:
· Writing down your thoughts about when you want to step away from the daily operations of the business.
· Would you like to spend more time with your spouse?
· What do you want to accomplish over the next 15 years and how much money do you need?
· What personal goals could you achieve if you weren’t running the company and what would success in a new endeavor mean to you?
· Discuss your ideas about the future with your family, senior management team and key employees.
· Decide how long you want to remain active in the company and in what capacity. If you see retirement as an opportunity to travel, be sure to include that in your discussion as well as where you want to live and what role, if any, you want to play in your community.

Long-term stability of the business.

Spell out what will happen in terms of shares of stock, assets or the buying out of the company by remaining principals or partner(s) if one of the owners or principals retires, dies or becomes disabled.
· Begin revising your business plan in conjunction with their successors —assuming you already have one—or write one if you don’t.
· Identify certain “trigger dates,” including dates when:

o You want to begin transferring ownership to others.
o Control is shifted, i.e., more than 51 percent of ownership of voting interests.
o The balance is transferred.
o Responsibility for day-to-day operations rests with your successor.
o You plan to formally retire.

· Determine the length of time you have available to train your successor.
· Appointment of a board of directors.

Family Issues

The head of a company has no greater responsibility than identifying a successor who will be equally or more successful in running the operation.
· The successors must have equal ability, motivation and commitment.
· You should not confer equal authority, compensation and stock ownership to them if their contribution to the running of the business is unequal.
· The successors must divide day-to-day job responsibilities according to their individual talents
· Successors must share a common philosophy about the future direction they want the company to take and must have a history of resolving conflict constructively.

Establish a grooming timetable to increase the chances for a smooth and ultimately successful transition.

Key Alternatives

If you are unable to find a successor among family members, set your sights elsewhere.
Your most likely candidates come from the ranks of middle and upper management.
When identifying a candidate—and you really should identify more than one—you need to ask yourself several questions:
· What are this individual’s technical and managerial skills?
· What are this person’s strengths and weaknesses?
· What needs to be done to prepare this candidate to step in?
· When do I see this potential successor being ready to take over?
· What if a key employee leaves the organization or dies?
· Can I walk away from the company and have it still function and survive?
· Have I delegated authority and trained people sufficiently?
· Have I developed an integrated system of performance reviews and cross training for a potential successor’s own development as well as for the firm’s security.

Succession Planning Financial Issues

The selection and training of a successor will all be for naught if you don’t also develop a financial strategy for handing over your business. A financial strategy protects:

· Your Company
· Your family and
· Your employees against a monetary burden against:

o The heavy gift taxes they will face.
o If you die, your heirs can suffer an equally prohibitive estate tax.·

You need to know what your company is worth.

· Setting up an employee stock option program is critical if you plan to sell your business to staff members.
· You may decide to sell your firm to a chain or a local competitor.

Valuation

Research shows most owners do not understand the relationship between valuation of an owner run business and a business that is run by systems, not necessarily computer systems but a combination of processes, procedures, feedback systems and automation.

It’s critical that you get an accurate valuation.

Such a valuation encompasses tangible assets such as

· Real estate
· Buildings
· Machinery and equipment

Intangibles like:

· Employee loyalty
· Manufacturing processes
· Customer base and
· Business reputation
· Patents on products and
· New technologies.

Professional valuation companies know what to look for and what questions to ask.

· Price can vary depending on the circumstances.
· The selling price to your children may be less than the amount you would ask from a large chain
· A fair value must be used, one that will withstand IRS scrutiny.
· Taxes can also influence how value is determined.
· To reduce potential estate taxes, you may want your accountant to argue to the Internal Revenue Service that your firm has minimal value.
· Current stock purchase price or buy/sell agreements may not reflect the dollar amount you believe the business is worth.

The most common methods for determining value are:

· Book value, which is reflected in your firm’s financial statements.
· Adjusted book value, which reflects the current value of your company’s assets (this method is more significant for a company with newly acquired assets or assets that don’t depreciate).
· Standard Valuation Methods, used by national and regional acquisition companies for valuing firms they’ve targeted for takeover.
· Capitalization of earnings methods, used by the IRS and the courts in valuing business interests for estate and gift tax purposes. These methods attempt to quantify the goodwill of a company in terms of its earning power, beyond the value of its operational assets alone.

Transferring Ownership

Your successor will help determine the method you use for transferring your business.
The structure of your company is another factor that will influence your choice of the transferring method.

If you are a sole proprietor

A sole proprietor and want to keep your company in the family:
· Think about federal estate and gift taxes, which can bite off as much as 60 percent of your estate after your death.
· Or if you plan to sell your company to a family member so you can retire:
o Make provisions through insurance policies to help your successor finance the purchase as well as pay for the ensuing taxes.

If you’re in a partnership

· Does your percentage of the business automatically transfer to your spouse or offspring upon your death
· As part of the partnership agreement, is your partner supposed to buy out your shares?
· Take out enough life insurance to provide your partner with adequate funds to pay for the purchase.

Closely held corporations

· Stockholders may stipulate that upon their death, their shares will automatically transfer to their surviving spouse or children.
· If the shareholder’s heirs subsequently want to sell their stock, sufficient provisions should be made so remaining shareholders have enough cash for the buy-out.

Gifting

Gifting allows the owner to transfer the business to the next generation over time in a way that reduces or even eliminates any estate or gift taxes.

· Each year an owner can give $10,000 to:
· A child tax-free:
o Husband and wife business owners can each give a part of the operation worth $10,000 to their child, for a total of $20,000.
o Neither the donors nor the recipient pay taxes on the gift. In addition,
The tax-free gift can be doubled each year if the donors give a $10,000 gift to the donee’s spouse
o And donors can give $10,000 tax-free to each grandchild as well.
· During your lifetime or upon your death, give away an additional $600,000 of the value of the business without paying any taxes.
· Your spouse has the same opportunity.
· Jointly you can make tax-free transfers of up to $1.2 million in addition to the annual gift of $20,000 per family member.

Trusts

The most common trusts used by business owners when planning their company’s future are testamentary and living.
· In a testamentary trust, you establish the provisions in your will, and the trust becomes effective upon your death.
· A living trust is created during your lifetime and can continue after your death. Unlike testamentary trusts, living trusts are not subject to probate.
You as the trustor:
· Determine the purpose of the trust
· The amount and type of property it will contain
· The length of time it will last
· And the trustees or beneficiaries
· The amount each beneficiary will receive, and
· When and under what conditions they will receive it.

Trusts can be irrevocable or revocable.

· Irrevocable trusts will save you money on income and estate taxes;
· Revocable trusts will help you avoid probate and, in some states, protect property from creditors.

Buy-Sell Agreements

Buy-Sell Agreements are a transfer method most appropriate to closely held businesses. Buy-sells enable you to:
· Safeguard your family’s financial future and
· Prepare your company to go on without you
· Bolster companies against all kinds of unforeseen events that could threaten their stability and perhaps survival of:
· Disability
· Divorce
· Death and plenty of events in between

Buy-sell agreements generally fall within two categories (A third type of buy-sell involves the sale of interest to key parties, most often prized employees):
· Cross-purchase agreements and
· Redemption or repurchase agreements.

In a cross-purchase agreement:

· The remaining shareholders of a company are obligated to buy the departing (either by retirement, disability or death) shareholder’s stock.
· The corporation itself as an entity is not a party to the agreement.
· Cross-purchase agreements enjoy certain tax advantages, in that proceeds from the sale of stock are treated as capital gains rather than as dividends.
· If you fund a cross-purchase agreement with life or disability insurance, creditors cannot attach the cash values of the insurance policies.

Redemption or repurchase agreements specify that:
· The corporation, via agreements made between the company and the individual shareholders, is obligated to purchase the stock of the departing shareholder.
· Each shareholder deals with one entity, the corporation, rather than several other shareholders.

Life Insurance

Life insurance policies can provide money to:

· Pay off estate taxes,
· Fund buy-sell agreements or
· Buy out a family member who is not interested in participating in the business.
· Provide cash for emergencies, helping you avoid selling your firm to outsiders if it’s hit by hard times.
· Funding medium that can be estate and income tax-free and even, in some circumstances, gift tax-free.
· Ward off any hazards resulting from your death or that of any other key participant.
· Should take into account any legal, financial, tax and technical complications specific to your operation.
· Should avoid plans that necessitate additional taxes.

NOTE:

This outline is intended to be a guideline only. Correct implementation requires review by professionals in each applicable field, including but not limited to attorneys, accounts, CPA’s, and financial planners.

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