Succession Planning

Just as every business is unique, business owners, too, have an endless variety of needs, objectives and hopes for the future of their companies. You may be wondering how and when you can step back from the business some day. But, understandably, there may be many questions and concerns keeping you awake at night. Getting a grasp on your business transition needs — and the many alternative strategies available to you — will provide a framework for achieving your goals.

Transition planning begins with analyzing the complexities of your business — including family and employee stakeholder interests, management succession needs, shareholder expectations and potential tax liabilities — to develop a complete picture of your current situation. Where you go next is up to you.

Stepping down, cutting back or moving on

There are many reasons you may be considering a transition. You may be eager for a well-deserved retirement. You may be ready to move on to another endeavor or feel it is time to hand over the business to the next generation. Perhaps you simply want to step back from day-to-day operations or think this is an optimal time to sell, merge or spin off the company. Whatever the reason, there are things you can do now to ensure a successful transition.

Beginning the planning process

Achieving your goals for the next stage of your business requires planning. If you see glimpses of your situation in the following scenarios, it may be time to talk to someone about transition planning. 

• You’re the maturing owner of a company you founded or acquired. You’ve grown the company through hard work and personal financial risk. You don’t want to see the business decline or move in the wrong direction some day.
  
  
• You’re worried about how estate taxes would impact the business. You don’t want the company sold to cover tax liability, but you’re not sure how to prevent this.
  
  
• Your children are in varying stages of their lives. One or two are involved in the business. Others are less engaged in operations but don’t want to be left out of decisions. You need a successor some day, but you don’t want to create animosity among siblings or disappoint anyone.
  
  
• Business stakeholders say the company is stagnating and you need to innovate. At your stage in life, you’re uncomfortable with high-risk decisions, but you don’t want the company to lag behind competition. 
  
  
• You have loyal employees who have been with you for many years. You believe they should share in the company’s success. Your potential successor doesn’t have a long history with these people and may not be as generous. You want to make sure your employees are provided for.
  
  
• Your management team is clamoring for capital investments to grow the business, but you have different priorities for (your) cash flow.
  
  
• You believe one of your children would make a good successor and should begin moving into a leadership role. Your spouse, who is concerned about your other children and doesn’t want you to show favoritism, believes the only equitable solution is to sell the business and divide the proceeds equally. You wish there  as another way.

Discovering the right transition strategies for you

Whatever you’re envisioning for the future of your business, chances are you can make it happen. But you’ll need to begin by plotting your course and identifying and removing potential obstacles.

Charting your course

The most critical undertaking as you begin this process is to identify and develop goals and objectives for your business, your family and yourself. This essential element defines, directs and motivates all other components as you move forward in developing the plan and setting it in motion. A couple of bromides are particularly applicable to this phase: “It is difficult to align a leaning building from the 12th floor, so make sure the foundation is set correctly,” and “When headed in the wrong direction, speed is not helpful.”

Take the time and effort to establish these objectives before starting down any path. Simply because some of these objectives cannot be fully defined currently is no reason not to continue the process.

This is a course that will become more refined as the future converts unknown factors into actual conditions. It is important that the plan has been established and developed as fully as possible, so that over time it can be implemented quickly and alternatives considered where appropriate.

Once your goals and objectives have been identified and delineated in as much detail as practical, the next step is to examine your business and all of its characteristics, attributes and challenges. This phase identifies modifications that can be made to various aspects of the business (management, ownership, tax structure, governance, etc.) to more closely align with and meet your business objectives.

Perhaps your personal mission is to retire in great health at 55 years old with financial independence and a strong management team in place. And the mission of your company may be to exceed your customers’ expectations and industry norms for profitability while being a good corporate citizen and rewarding your employees.

To achieve your personal and business goals, your succession plan and strategic business plan must be coordinated and managed around these objectives. This will require careful selection of your successors and others who will carry out your plans as you begin the process of stepping back.

Developing your process

Devise a timeline for the transition process that will allow your successor to assume leadership gradually. Allow yourself plenty of time to prepare for departure, while making yourself available to lend professional advice to your successor.

Transition strategies and techniques

There are many strategies available to make your transition easier, reduce unnecessary tax erosion, and accomplish your goals in the most effective manner possible. These options may be combined and customized to your needs. Components of this plan may include the following:

• Gifts of interests in the business: If the plan calls for family members to own interests in the business, a variety of structures are available to make transferring that interest more tax efficient. Variations of the transfer structures can segregate the control and value aspects of the business into separate interests that can be transferred to different family members. This can better reflect the family members’ proper relationship with the business and other family members. Transfers such as these can be designed to effect a systematic transfer mechanism over a period of years, or actually postpone the recipient’s beneficial ownership and control of the business interest being transferred.
  
  
• Conversion of value to cash: A number of options exist to convert a portion of your interest in the business to cash. This can accomplish a variety of goals, including diversification of your wealth, increasing cash flow and reducing your ownership of the business for tax planning purposes.
  
  Among the techniques to accomplish some of these goals are:

1. Restructuring of the business entity itself so that it is more tax efficient, such
   as an S Corporation election 
   
2. Spinning off a division into a separate entity that can be dealt with independently from the original business 
   
3. Repurchasing some (but not all) of your interests in the business.

These and other potential options cannot be effectively considered and evaluated until your objectives have been developed and your business “stress-tested” against your plans and objectives.

• Payments of phantom stock, stock appreciation rights, stock option and other equity participation plans: These arrangements can be designed to motivate and retain key employees, make them think and act like owners, and give them an equity position in the company that is protected by a buy-back program. If the optimum plan is to continue to operate the business for the benefit of the family, the successor management needs the incentive to continue with the company. They also need the assurance that their interests are protected and are consistent with those of the controlling owners. These arrangements require employees to pay taxes only, rather than the actual cost of purchasing ownership.
  
  
• Employee stock ownership plan (ESOP): An ESOP can be a means of motivating employees through a long-term ownership position in the company. Where this tool aligns with your goals, it can provide a very effective method of motivating and rewarding employees who have helped you achieve success in the business. An ESOP can be a very tax efficient way to provide investment diversification for you and tax benefits for the business.
  
  
• Sale of the business: In some cases, the analysis of the business in relationship to your goals will lead to a conclusion that the business should be sold. Some business owners will want to embrace this option only after a thorough analysis and investigation of all other options. For others, it may be their first choice. In either case, substantially better results can be achieved by long-range planning and preparation to take full advantage of various structures and tax benefits in completing the sale. Timing is crucial, and a longer period for preparation provides opportunities to benefit all stakeholders in the business and, potentially, charitable organizations and initiatives whose goals and vision you share.

There are other options not covered here, and many of the options listed above can be combined.

How Freed Maxick & Battaglia, CPAs Can Help

Our experience with owner-managed businesses — and our commitment to understanding and executing your objectives — make us an ideal advisor for your transition planning needs. We have utilized the strategies outlined above, as well as others, over the years, and continue to refine and update our knowledge and processes to fit individual client needs.

Our understanding of family and organizational dynamics helps enable a smooth planning process aimed at optimizing outcomes for stakeholders. This approach also facilitates continued business success and helps maintain strong family relationships. Our primary goal is to help family-owned and closely held businesses maximize their success across generations.

Developing your unique transition plan

Your Freed Maxick advisor will listen to you — and others you wish to involve in the transition process— to develop an accurate, realistic understanding of your ownership situation. Once we understand what’s important to you, we work with you to develop strategies that can help you achieve your goals. The effectiveness of each tool and process for successful plan implementation must be specifically measured against your goals, in your situation, regardless of what may have worked for others.

Our decades-long focus on businesses like yours provides insight into those tools and processes that are frequently useful. They may include (but of course would not be limited to) some of the following:

• Reduce future transfer costs and estate taxes
  
• Trusts can be used in combination to provide management protection and control for some beneficiaries.
  
• The sale of a certain portion of the business (stock or other interests in the business) can be made to a “defective grantor trust,” perhaps using a “self-cancelling installment note.”
  
• The business interest can be transferred to a trust providing annuity payments to the owner for a period of years, creating a so-called ”grantor retained annuity trust.” This provides an effective method of transferring value and business interests, while retaining significant cash flow from the business to the current owners.
  
  
• Enhancing the benefit of any life insurance assets
  
• Life insurance plans should evolve to reflect changes in policyholders’ – and beneficiaries’ – life situations. It’s important to position life insurance in a structure that makes certain that funds are available to the business or family when needed in a tax-efficient manner.
  
  
• Business control agreements
  
• To effectively anticipate and determine the ownership flow of your business, buy-sell agreements and owner control agreements must be drafted to reflect your current wishes and the present state of the business.
  
  
• Family partnerships
  
• A partnership of family members often can provide effective control of family assets without fragmenting the ownership of such assets.
  
• Such partnerships can also play an important role in the family’s overall tax planning strategy, as long as the strict rules laid down in various court cases and other tax rules are rigorously followed.
  
  
• Business entity structures
• Examine the possibility that a certain portion of the business should be split or combined from an ownership or entity for a variety of reasons.
  
• Establish the most effective ownership structure possible based on the goals and objectives established at the outset. Even clear and well-articulated plans can be hindered by misaligned ownership structures.
  
  
• Compensation devices
  
• Examine the use of nonqualified deferred compensation plans or qualified retirement plans to provide cash flow to you that also provides an ordinary deduction to the company.
  
• Provide compensation programs to key employees that encourage them to remain with the company and contribute to its success, so the cash flow is there to support the transition process.

Contact Our Succession Planning Advisors: 

Toll Free: 1-800-777-4885

Shawn Frier, CPA	Kathy Carey, CPA, CFP	Tim Dalton, CPA	Adrienne Schreier, CPA
Director	Director	Senior Manager	Senior Manager