For most closely-held business owners, their business constitutes all or a large part of their assets and retirement savings.  These owners have been pouring blood, sweat, tears and their savings into keeping the business running.  As such, ensuring that the business they worked hard to develop is either maintained in the manner the owner deems appropriate or sold to leverage the highest value, is of the utmost importance.  Business succession planning should not be overlooked in this regard and should not be pushed off until it is too late.  Too often business owners pass away without a succession plan in place; leaving the business and the heirs in unchartered territory without a clear path forward.

A business succession plan should address the systematic transfer of the management and ownership of the business.  With regards to management of the business, the succession plan should include, at a minimum, the following:

·         development, training, and support of management successors;

·         delegation of responsibility and authority to management successors;

·         whether outside directors or advisors are necessary to bring objectivity to management successors; and

·         maximizing retention of key employees through equitable compensation planning for management, family and non-family employees, and other active members or shareholders.

A business succession plan must also consider ownership of the entity.  If the business is owned by co-members or co-shareholders, buying out the owner’s shares or interest upon death is often contemplated.  The Operating Agreement/Buy-Sell Agreement will typically have a provision requiring that the living owners or the LLC/corporation purchase the interest from the estate.  Life insurance or an irrevocable life insurance trust can be established to cover the costs associated with the buy-out and ensure the necessary liquidity if new key people need to be brought in.

The Operating Agreement/Buy-Sell Agreement will also establish the manner for selling membership interest/stock upon retirement.  Typically, the selling owner must first offer the ownership interest to the non-selling owner(s) using a pre-established formula or providing a bona-fide third-party offer to the non-selling owner(s).  This ensures that the remaining owner can keep control of the entity if they so desire.  If the non-selling owner refuses to exercise this right of first refusal, the selling owner may then sell their ownership interest to the third-party.

If, on the other hand, the LLC/corporation is owned by a single owner, the business succession plan needs to coordinate between who will run the business and who will manage the business, if different, as well as the timing of the ownership transfer.  If the selling owner sells the business during their lifetime, a non-compete is usually included in the purchase of the business to ensure that the selling owner does not get back into business and compete with the entity that he or she just sold.  If the business is being sold after the passing of the owner, the succession plan will detail who the ownership is passed to and how much of the ownership is passed to each individual/entity.

When the owner is selling during his or her lifetime, the retirement portion of the succession plan is paramount.  To help achieve financial security, the selling owner should consider nonqualified retirement arrangements such as an executive deferred compensation retirement plan, or qualified arrangements such as a pension or profit sharing plan as part of the sale of the business.  The owner should also consider whether leasing real and personal property necessary to the operation of the business could serve as additional sources of retirement income; this is often why an owner will establish a holding entity and an operating entity.  The holding entity owns the land and building while the operating entity runs the business and owns the goodwill of the business.  Separating the two entities is not only financially prudent when considering retirement and options for selling (i.e., the ability to sell one or both entities), but also with regards to liability considerations. 

Liquidity issues also often arise when the torch is passed between business owners.  Liquidity is necessary for the business to meet future contingencies and to create reserves for ongoing capital needs.  It may be necessary for the business or the business owners to meet obligations under the Operating Agreement/Buy-Sell Agreement.  It may also be necessary for the owner’s family to meet estate tax obligations.  An irrevocable life insurance trust is an effective vehicle in ensuring liquidity upon one of the owner’s death thereby triggering a buy-out or estate taxes.  A payment schedule for buying out an owner upon retirement also helps ensure that the business is not saddled with a significant up-front payment while also helping the owner avoid the tax consequences of a large lump-sum payment.  

As we help clients plan and navigate this detail of business, especially a family business, we look for the right option for each circumstance and as you can see there are quite a few variables to consider. You can be assured that we empathize with your situation and know how difficult it is to begin. Let us help you navigate this phase of business.

The material contained herein is provided for informational purposes only and is not legal advice, nor is it a substitute for obtaining legal advice from an attorney. Each situation is unique, and you should not act or rely on any information contained herein without seeking the advice of an experienced attorney. All information contained in links are the property of the linked site.