Human nature is such that when we experience something good, we forget there’s a possibility of something bad happening. For example, when we’re in the perfect relationship, we don’t think of or plan for a break up. Similarly, when it comes to a business, people are so busy trying to make it successful, they don’t plan for a day when they won’t be around to run it anymore. Even if it seems unnecessary and retirement is a long way away, it is important to map out a business succession plan. There are many unexpected scenarios like divorce, disability and death that require a company to have a succession plan in place.
Before developing a business succession plan, be sure to consider the following:
Choosing a successor
Those who run a family business actually have a more complicated decision to make than many think. If the owner has more than one child who wants the role, emotions and ego can be at stake. If the owner has children who don’t want anything to do with his or her company, he needs to identify someone in the company to carry the business forward. Regardless of what the case is, there are steps in place to selecting a successor.
1.) Evaluate each potential successor’s strengths and weaknesses to assess if they are fit to fill your shoes.
2.) Make a plan for those who will eventually take over leadership and ensure they are experienced enough to succeed. In a family business, there will also be estate and inheritance tax issues to be resolved.
3.) If selling to a business partner, be sure to have a buy-sell agreement to create the financial structure for your exit.
Business valuation
If your company is privately held, a valuation should be conducted through certified appraisal or by an arbitrary agreement between partners as to how the business will be valued.
Business transfer methods
Cross-purchase agreements and entity-purchase agreements are the two most common ways of transferring business ownership.
1.) Cross-purchase agreement – Every partner in the company buys and owns a life insurance policy on other partners. Also, each partner is named as both owner and beneficiary on the same policy. If one partner dies, the policies are paid out to the remaining partners. The proceeds are then used to purchase the dead partner’s shares in the business at a formerly agreed-upon price.
2.) Entity-purchase agreement – The business purchases a life insurance policy on each partner and is named the owner and beneficiary for each policy. In case a partner dies, the business uses the proceeds to purchase the decedent’s shares. With this arrangement, the cost of the policies are usually deductible.
