Owners are often too busy running their companies to take the time to properly plan far enough ahead to their eventual departure from the business.
Tim Jochim, chair of the Business Succession & ESOP Practice Group at Kegler Brown Hill & Ritter, says that there’s often some kind of catalyst, such as a health condition, that forces an owner to begin the process.
“Succession planning should be a 10-year process, minimum, before an owner exits,” says Jochim. “It’s a planning issue, and owners should set up the process relatively early on.”
Smart Business spoke to Jochim about what business owners need to consider during the succession planning process.
What are the management issues that owners face when considering exiting the business?
The key to the long-term success is the management quality of the business, no matter who owns it. This is an area where owners of closely held or family-owned businesses probably don’t spend enough time, especially early on in the planning and development stage. They have to recruit, develop and retain good management. If it’s a family business, it becomes a little more complicated. If the owner/founder wants the family in the business and tries to devise something that is fair to the individual members of the family, that fairness he’s seeking within the family may not necessarily be best for the business. Further, you may have the complication of outside managers or executives interacting with family members.
The business should come first. If family members are involved in the business, they should a) work their way up within the business, and b) spend some time at an outside business so they gain a broader perspective of what the management process is like.
What are some of the options for transferring ownership?
The options are relatively simple and straightforward. If it’s a family business, usually there’s going to be some combination of gifting, bequest and purchase by family members. If you started a business with other investors, then generally there’s a cross-purchase agreement funded by life insurance where, if one person leaves, the others have a right to buy his or her stock. If no one wants to buy it, the company has a right to redeem it. If the company doesn’t redeem it, then the exiting shareholder can sell to the outside. Usually in the buy-sell agreement, there is a built-in process — a cross-purchase or redemption — and if none of those is implemented, then the outside sale comes in to play.
On rare occasions, the company does have an opportunity for an initial public offering.
In an employee stock ownership plan (ESOP), the advantage is that the purchase of the stock is deductible. It’s expensable and it is pretax dollars. So if I’m an owner and the ESOP buys my stock, it’s funded or paid for by the company, but the company can deduct that expense. If the company is a C corp., they can structure it so that they don’t pay the capital gains tax or the Ohio income tax associated with any gains from the sale. That’s two advantages of the ESOP.
