I have found that most small businessmen and women have not considered what happens to their small business once they become disabled or die. Like me, they think they will continue to work forever with no real thought to ever shutting down the operation. Mostly, they are too busy with the day-to-day to have time to think through what happens 10, 20 years from now. In fact, nearly three out of four business owners lack documented succession plans (which can include buy-sell agreements) for senior roles.
However, proper planning is so critical. At this very moment, I represent a family embroiled in litigation following the death of the founder of the business. He did estate planning but very little business succession planning. A recent Forbes article highlights some areas of consideration.
First, think about tax implications of the move.
If you’re thinking about selling your business, making it a point to discuss your exit plans with tax and estate planners is essential. Setting up a meeting with an accountant who is familiar with succession and transaction planning can help you develop a plan and move you in the right direction. Make sure to discuss your estate plans and tax situation as soon as possible. Producing at least a few years of accurate tax returns that show maximum profitability can help in preparing your succession plan. The longer you wait, the more difficult it can be to assemble tax strategies and mitigation.
“There are certain ways that a sale or buyback by the company can be structured to minimize taxes or to allow them to be paid over time,” she says. Without consideration of tax matters, an owner planning to fund his or her retirement by selling shares could wind up with drastically reduced proceeds.
Second, do you expect an income stream from the business after you are “retired?”
Transitioning into retirement can be difficult for some business owners, especially for those who have built their businesses from the ground up. If this is you, you’ll want to protect the business that you have nurtured and sustained while also feeling secure financially. First, make sure that you have enough to live on during retirement. Then consider working with an M&A professional to help plan your succession.
Third, and I think this is most important, who will run the business after you are gone?
Identifying an ideal successor is necessary as soon as you start to think about retiring. A business broker can also assist you in finding a buyer you are comfortable with. Knowing that the business you started will be well taken care of will give you peace of mind in letting go.
Fourth, can you step away emotionally? Will you want continuing “influence?”
Realizing that your business will be in the hands of a new owner can be stressful and leave you with insecurities, but finding the right buyer can put you at ease. Again, dealing with these uncertainties starts with having a well-executed plan. The more prepared you are for selling your business, the easier it will be.
I do disagree with a statement in the opening paragraph, though.
Diligence is one of the most important aspects of succession planning, so it is crucial to start planning immediately once you decide that it is time to move forward and sell your business.
Planning starts now.
I would also advise you to consider some other issues. Do you have a partner or fellow shareholders? If so, a buy-sell agreement should be in the arrangement NOW.
A Buy-Sell Agreement can specify trigger events, voluntary or involuntary, and contain all the terms for a situation when a departing partner wants to protect his or her value in the partnership. Such agreements are additional to the business agreements of an LLC or Corporation.
A buy-sell agreement handles “partnerships” wherein one party quits, or wants to do something else. Do you want to enable a partner to sell his interest to a third party? If so, you may want to include a first right of refusal. What about giving interests to family members or spouse? Or as suggested by one Forbes article:
How would you like your business partner’s ex-spouse to help run your company? Does it sound like fun to have a bank own part of your business should your co-founder file for personal bankruptcy?
A Buy-sell Agreement also handles what happens if one partner becomes disabled or dies. Rachel Flaskey, a senior manager at a top 15 accounting and advisory firm in the U.S. says:
“Those are all circumstances that can be planned for somewhat,” she says. “But you also have the unforeseen circumstances: an argument or the shareholders aren’t clicking anymore. Or maybe you want to allow future owners into the business.”
While business “divorces” occur, most times these questions arise when a partner dies. Who is going to purchase an owner’s interest if he dies or can’t contribute to the business any longer? Often, stock redemption or a cross-purchase agreement are used.
Buy-sell agreements should outline not only how price is determined, but also who can or can’t be a buyer and how a business sale will be funded. This is helpful in circumstances where owners want only certain family members to be able to buy out ownership and to control decisions. A clause outlining what may trigger the sale of the company can prevent having fiduciary agents (such as lenders) take control in the event of a personal bankruptcy by one owner. Outlining how any sale of ownership is to be funded (cash, debt, insurance proceeds, etc.) helps ensure proper planning of company liabilities, Flaskey says.
Can your divorced “partner” start a competitor? A Buy-sell agreement can include non-compete provisions.
Also, how will the purchase price be determined: by appraisal or set formula? In another business “divorce” in which I litigated, this was the source of the contention. The parties have vastly different ideas about the value and its on-going value without one of the business owners. Per Forbes:
Buy-sell agreements should include a business valuation clause. Some owners want to include a specific formula for valuing the business (e.g., “four times earnings before interest and taxes”), but the formula may not reflect the workings or true value of the business when it is applied, according to Flaskey. Business owners are better off with a clause in the agreement outlining that a business valuation expert will assess the appropriate ways to value the business.
And lastly, how will they pay? If they don’t have liquidity to pay, the best Buy-Sell Agreement may be defeated. In my opinion, a life insurance policy securing the buyout obligations is a great way to protect this situation.
As I said earlier, planning occurs NOW.
The time to create a buy-sell agreement is well before it is needed. As Flaskey says, “It’s a lot easier to get an agreement in place when everyone’s in agreement.” By the time circumstances warrant utilizing a buy-sell agreement, people could have other interests at play, making it more difficult to reach agreement on various items. And while it’s really never too early in a business’s life to develop a buy-sell agreement, keep in mind that business needs evolve as the business evolves and could warrant changes in certain agreement provisions over time.
Don’t keep your family in the dark. Use your family as a sounding board so they are familiar with the business. Also, lease a paper trail for them.
Consider the following questions when beginning to form a succession plan prior to meeting with an advisory team:
- What are the current and future prospects of the business and the land improvement industry as a whole? If the business is struggling or expecting difficulties, receiving an interest in the business may be more of a burden than a benefit.
- What is the current and anticipated future role of each child within the business?
- Which child has shown the greatest ability with regard to the operation and management of the company?
- Which child has shown the greatest interest and knowledge regarding the land improvement industry?
- Which child has the best vision for the company moving forward? How should the ownership interests in the company be valued? Is the valuation method established in the governing documents of the business?
- Which child should have the greatest ownership percentage in the business?
- Should one child receive a greater than 50% ownership interest in the business, granting authority to have the final say in cases of disagreement among the owners?
- Should one child receive the entire business?
- Are there certain individuals working for the business that should receive a percentage of ownership in the company other than the children?
- Are there assets, such as certain construction equipment or supplies, outside the business which are important to the functioning of the business that need to be passed on to the child who will be the primary owner of the company?
- Whose name(s) is on the deeds and titles of any machinery registered and used by the business or real estate belonging to the company?
- What assets do we own that may be passed on to the children other than the business? Generally, how should these additional assets be valued and divided among the children to balance against children receiving different ownership percentages in the company?
- What team of advisors should we work with in creating a succession plan?