Business Succession Options
A succession plan for your business is one of the most important safeguards you can use to help ensure the company’s future success. Approximately one-third of family businesses that transfer to the next generation result in success, and only 12 percent make it to the third generation.* Choosing tomorrow’s leaders and formulating a plan for your retirement, death, divorce or even disability are tasks that should be done early and tweaked often. The transfer of power and wealth can provide a smooth transition or can be the demise of a company, depending on how future leaders are chosen and groomed, and how tax and estate planning implications are handled.
* The Better Business Owner/Business Succession Options Advicent Solutions, an entity unrelated to Prudential. © 2019 Advicent Solutions.
Succession options available to the owners of privately held businesses.
– Transfer of ownership to the next generation
– Employee stock ownership plan (ESOP)
– Sale of the business to a third party
– Liquidation of the business
Whether your successors are family or not, it’s important that you begin the succession process early. The first step is to recruit talented employees from the beginning and help them develop their leadership skills within the company. You should also get them comfortable with taking over long before they actually have to step in, to ensure a smoother transition. It may also be helpful to get clients used to the new leadership before they take office. Adequately preparing your successors is one of the best things you can do to maintain your company’s success in the next generation.
ESOP
If you choose to transfer the business to your employees, an Employee Stock Ownership Plan (ESOP) may be a solution. An ESOP is a qualified plan designed to benefit all employees and must be non-discriminatory (in other words, it must not provide a greater benefit to one class of employees over another).
Unlike other qualified plans, an ESOP can borrow money to purchase investments in the stock of the sponsoring corporation. An ESOP is one method for business owners to plan for the transfer of ownership. In addition, an ESOP provides tax advantages to the selling shareholders that assist in maximizing the value of the business.
With an ESOP, the business owners sell their shares to an ESOP trust. The trust in turn makes annual contributions to the accounts of the employees. One key issue that must be addressed with an ESOP is the concept of repurchased liability. The sponsoring corporation must create a market for the employees to redeem their vested shares upon certain events (e.g. death, retirement). It’s important to give careful attention to this issue.
Sale
You may choose to sell your business to someone who is not currently involved in the company—a competitor, an existing customer or supplier, for example. This can be done as a lump sum sale or in the form of an installment sale that spreads the payments and tax implications over a number of years. The sale of the business may be structured as an asset sale, a sale of stock or a combination of both. As a business owner, you are motivated to sell the stock in your business in order to take full advantage of the lower capital gains tax rates (a sale of assets usually subjects a portion of the gain to ordinary tax rates).
However, the market and other factors may dictate the nature of the sale. You should discuss the options available to you with your advisors.
Liquidation
If there is no market for the business as an ongoing entity and other options are not available, you may choose to close the business and liquidate its assets.
Buy-Sell Agreements
What will happen if you or a business partner wishes to retire, dies prematurely, becomes permanently disabled or gets divorced? Most closely held businesses need to have a buy-sell agreement in place when other partners, principals or shareholders are involved. Most commonly, this agreement states what occurs in the event that a partner/shareholder should die, but it should also include provisions for retirement or other departure, disability and for the divorce of a partner.
If you are an individual business owner, many of these items still apply; you simply have the added challenge of determining who will purchase your business in the occurrence of one of these events. A properly structured buy-sell agreement stipulates in a binding contract what occurs in any eventuality.