Entrepreneurs spend most of their time, energy and sometimes life savings developing a business. As these people work and plan to make their business successful, they rarely consider what they will do with the business when they want to retire, when they die or how estate taxes attributable to the business will be paid. Business succession planning is necessary to developing a business and must be outlined as soon as a business is developed.
To transfer a business successfully from one owner to the next, succession planning should commence as early as possible. “I have never seen a business fail due to payment of estate taxes when there was proper succession planning,” says Richard Kissel II, a director with Sommer Barnard and chair of the Estate and Business Succession Planning Group.
Smart Business spoke with Kissel about the planning options business owners have and what factors should be considered when developing a succession plan.
What options do business owners have when planning the future sale of their business?
Most business owners work very hard to build a successful business. Therefore, the decision to give up control of their investment can be very difficult and require much planning and research. Typically, there are three primary options for the future of a business. Owners can begin to structure a plan to pass control to their children, pass control to an inside management group or they can sell the business to a third party with whom they are not affiliated.
In most cases, it is human nature for business owners to want to pass their investment to their children. This option depends on whether business owners have children who are willing and capable to run the business. This option is not always feasible, so other options are often utilized.
What factors must business owners consider when selecting a future owner?
Business owners need to take a realistic look at the situation as a whole. Pride and emotion are involved with companies that individuals create. The key is to take an outside look to see what decision is best for the future of the company as well as the owner’s personal future.
If children are involved in the business, the owner must evaluate their managerial skills and their capabilities to run the company in the future. If they are going to successfully operate the business, the children must have knowledge of the industry and must be able to keep developed relationships with customers and others for future business.
Cash flow from the business must also be evaluated. Business owners must know how much cash flow is needed to support them comfortably in retirement and to provide reasonable compensation for the new owners.
A seller’s interest in the future success of a business often depends on how the seller is being paid. If they are selling to a third party, they should try to obtain almost all the purchase price upfront. In that case, they can be less concerned with the future success of the business. While the former owner may be disappointed, they are not affected financially and have less at stake if the business should come to an end. On the other hand, if they sell to their children or a management group with little money paid upfront, the failure of the business could have catastrophic effects on the seller’s personal future.
The owner should also determine how much input, if any, he or she will have in the business after the transfer. If a business is being sold to a family member, the amount of input the seller has following the sale usually depends on the family dynamic and the payment plan. If the seller is being paid over a period of time, he or she usually has some right to be involved in the business after the sale. In other situations, there may be a need for the seller to let the new leaders have complete control. The decision should be made based on the future of the business.
How can business owners design a financial plan for the successful future of their business as well as personal needs?
The longer period you have to plan, the better. The senior generation can make gifts of stock or other interests of the business to children over a period of time. This is less stock that children may have to buy at the time of the transfer to them. The less strain there is on cash flow because of the sale, the greater the chance of a successful transition.
If a third party is purchasing the company, the plan depends on the owner’s cash needs for retirement and the business’s ability to generate cash. If a business is being sold to someone unrelated to the current owner, it can be crucial to obtain as much upfront cash as possible.
Succession planning funds the senior generation’s retirement, it creates wealth for many generations of the family, and if done correctly helps the business succeed for generations to come. It also preserves the business that the senior generation has spent much of their life developing.
RICHARD KISSEL II is a director with Sommer Barnard and chair of the Estate and Business Succession Planning Group. Reach him at firstname.lastname@example.org or (317) 713-3500.