Business succession often fails because business owners failed to plan, not because of a failure of the plan itself. But once a succession plan is established, it requires periodic review because tax laws change, goals change, dreams change and outcomes change.
“Often I find a business, particularly when it’s closely held, is one of the biggest assets of a family. So you’ve got to treat it that way,” says Rick Applegate, President of First Commonwealth Financial Advisors. “People get so close to their business that they forget, or fail to, look at it objectively.”
Smart Business spoke with Applegate about what to consider with business succession.
Why do business transfers to another generation often fail?
Assuring continuity is vital, but it doesn’t always mean that a second generation can assure success. A business succession strategy needs to take into account the business owner, the buyer, key employees and, most importantly, the clients.
Many times, owners of a closely held family business want to be ‘fair’ to all their children. So, a sibling who hasn’t been involved gets an interest equal to that of the sibling who has worked in the company for many years. Fairness has nothing to do with a successful business succession. Work out some other way, such as taking out a life insurance policy on yourself to benefit the uninvolved son or daughter.
How does a defensible business valuation help?
Understand what you’re trying to do — are you selling to family members, on the open market or to internal employees? One of the first things a buyer wants to know is the cost, so you need a supportable valuation to put a price on the business.
Even if you’re not selling, a business valuation is helpful. If the company hasn’t been properly valued at your death, the IRS will value it as highly as possible to collect more tax when your estate executioners sell or transfer the business.
It’s important to bring in appropriate professionals like attorneys, tax accountants, financial planners, etc. People who are closely vested in their business almost always think it’s worth more than it is. Professionals can help guide you to a reasonable valuation, including picking the best methodology.
What else should you take into account?
You need to think about who would be interested in buying your business. It might be difficult to sell in the open market. Family members could be disinterested. So, employees may be an option. Employee stock ownership plans have tremendous tax benefits to the prospective seller. Today’s low interest rates also easily allow a stock transfer with a bank loan. Again, qualified professionals can help with sale contract language and other matters.
In addition, you might not have the option of active, thoughtful selling. Plans must weigh what happens if there’s financial hardship, injury, disability or even death. Business succession planning should go hand-in-hand with your estate planning.
When family members are under duress, you don’t want them scrambling with business operations or estate matters. Leaving the business to your uninvolved spouse may be a terrible position to put him or her in. And it can hurt the value if they end up having a liquidation sale.
Use the plan to put your successors in the best position. Ask who is key to the continued success of the business. Do you need to give key employees part ownership or incentives to stay?
How can the right financing help with the plan’s execution?
There are different ways to sell a business. Prospective owners often utilize life insurance purchased under an agreement of sale because it makes the outcome a known entity. This is particularly useful when the buyer is paying through installments. If the business owner dies in the transition period, the life insurance awards funds to pay for the remainder of the company.
There are a lot of details to wrap up with business succession. Even after a sale, the right parties must be notified so previous owners or survivors aren’t liable for the unemployment tax filings, tax returns, business credit cards, etc. With help from experienced professionals, your plan can anticipate and respond to ensure the business continues after you’re gone. ●
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