From tax consequences to issues of control, a lot is riding on the decisions you must make for your company’s future.
By T. Teal Dakan & Abe Cole
As long as businesses are managed and owned by humans, business succession will happen. Will it happen in an orderly fashion, according to a thoughtful plan based on the owner’s wishes? Or will it be sorted out by those who remain after the owner is gone? We favor the first approach.
Business owners usually complete certain projects, such as audits and tax returns, annually without fail. It’s no coincidence; these projects have well-defined outcomes, and they have specific deadlines enforced by a third party, such as a bank, a regulator or the IRS. They also often involve a single adviser, making them relatively simple to coordinate.
So why is the business succession process so hard to get started—and finished? Unlike an audit or tax return, the outcome of a succession plan is not well-defined. It is waiting to be designed to each owner’s specifications. It’s unusual to have a deadline enforced by a third party. It also involves coordination of multiple advisors, including a CPA, attorney, banker and investment and insurance advisers. Given all of these factors, the owner may not even know where to start.
Allow us to suggest this list of six questions every business owner must ultimately answer about business succession and its effect on the personal wealth and legacy of the owner.
Who will run the business when I am gone?
If the success of a business is too reliant on the skill, vision and passion of its owner, it may be difficult to continue the business legacy or get the most value in a sale without that owner. Successors must be identified for the owner’s various roles, and the right people must be directing operations, sales, finance and other key areas. Appropriate incentives should be in place to retain key employees. Assessment of the management team also will include identifying the role for any family members working in the business.
Who will own the business when I am gone?
Ownership can change hands in several ways, including transfer to family, sale to management or an employee stock ownership plan (ESOP) or sale to a third party. Transfer to family could involve gifts during life, bequests at death, sales or some combination of these elements. Sale to an ESOP could have tax advantages for the owner but also has financing issues and ongoing compliance costs to consider. Sale to a third party must involve thoughtful preparation to get the best sales price.
Is the business ready for a transition?
A realistic assessment of where the business stands today includes a detailed review of the key areas of the business, including sales and marketing, production and delivery, accounting systems, management information and technology. Changes in operations or ownership structure may be needed to facilitate the transfer in the desired manner and at the appropriate value.
What are the income, estate and gift tax consequences of making a transition?
The business often is the most significant asset in the owner’s estate. Therefore, tax planning must address not only current income tax issues but also estate and gift tax issues and related income-tax basis considerations for heirs. The owner’s personal charitable objectives may also help reduce the tax cost of the transition.
How will my cash flow and lifestyle be affected by the transition?
Personal wealth planning is essential for a successful ownership transition. It will affect how a business transition will be accomplished and at what price. The after-tax results of any proposed transition should be projected to confirm sufficient resources will be available to meet the owner’s living needs, charitable intentions and family legacy objectives.
What will I do when I am no longer immersed in running the business?
The owner should determine nonmonetary retirement objectives and develop a plan to achieve them. These may include travel, more time with family, charitable or civic pursuits or new business creation.
This brief discussion won’t solve the business owner’s succession dilemma. But it may provide a framework to help identify areas of greatest concern and a place to start the process. Remember: The answer to one of the questions will often impact or depend on the answer to another. The process takes significant thought, coordination and time. There is no better time to start than now. Good luck!