Business Succession Planning: 5 Ways to Transfer Ownership Of Your Business,How Succession Planning Works
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There are several key steps necessary to create a comprehensive small business succession plan, and several ways to go about creating your plan. Some business owners may choose to create their own succession plan, while others may wish to engage the help of a professional, depending on the complexity of the plan and the business. Whether you create your plan yourself or engage a professional, the five steps to writing a succession plan are:. Creating a small business succession plan can be complicated, and many business owners choose to engage a professional third party to help them determine the value of the business, the type of succession plan, and create any supporting documentation.
The choice of provider may be based on the complexity of the business as well as the event being planned for. Provider: Best for PwC Private mid-size businesses with complex structures and many employees Local Business Attorney Small companies with several employees and simple financial structures Local CPA Small businesses with several employees and complex financial structures SCORE Small companies few employees and simple financial structures seeking long-term mentorship SBDC Small companies with few employees seeking one-on-one training and assistance Whether you choose a large accounting firm or a local certified public accountant CPA to assist in your succession planning will depend largely on the complexity of the business, and how many employees are involved.
For small businesses, including a sole proprietorship, business owners might consider seeking the help of a small business mentor, using services like Service Corps of Retired Entrepreneurs SCORE and Small Business Development Centers SBDCs. For small businesses with multiple employees and simple to complex finances, a local CPA may be a viable option, or you might consider hiring a business attorney to help you draft the paperwork. For more complex scenarios, a business attorney and CPA should likely be involved, to ensure that everything goes smoothly when the succession plan kicks in. Finally, for larger, more complex businesses, business owners may wish to consider working with an accounting firm with extensive experience in creating business succession plans.
There are hundreds, if not thousands, of such firms. Time changes many things and, for your succession plan to be effective, it needs to be reviewed regularly and updated to reflect any changes. These could be company changes, tax law updates, changes in valuation, or new industry developments, among other things. Business owners must update and adjust their business plan to reflect changes such as these. Many business owners want to transfer their business to their family members in a way that minimizes the tax cost, holds the business assets in asset protected structures, continues the cash flow to the business owner post succession, and ensures a successful transition of management to the succeeding family members.
Other business owners are selling their business to a third-party buyer. Again, allowing time to prepare the business for sale will reach the highest possible price, and allowing time to properly structure that sale will allow the transaction to incur the smallest legal tax liability and the greatest level of wealth protection upon receipt of the sale price. Liquidating and closing up shop—not selling out—will be very unprofitable. The majority of the value of most businesses is in their goodwill and intangibles, not their hard assets. While many experts recommend beginning succession planning three to five years ahead of retirement, it is never too early to begin. Find Robert On LinkedIn.
He recently spent six years leading a team of small business financing professionals, facilitating the deployment of critical capital to over 9, small businesses across the US. Sign up to receive more well-researched small business articles and topics in your inbox, personalized for you. Fit Small Business content and reviews are editorially independent. We may make money when you click on links to our partners. Learn More. WRITTEN BY: Robert Newcomer-Dyer Published October 11, There are five common ways to transfer ownership of your business: Co-owner: Selling your shares or ownership interests to a co-owner.
Heir: Passing ownership interests to a family member. Key employee: Selling your business to a key employee. Outside party: Selling your business to an entrepreneur outside your organization. Company: For a business with multiple owners, you can sell your ownership interests back to the company, then distribute them to the remaining owners. How a Business Succession Plan Works A business succession plan is a document that is intended to guide through a change in ownership by providing step-by-step instructions. A small business succession plan should include the following: A succession timeline: Details regarding the circumstances when a succession would take place and specific dates as applicable. Your potential successors: A list of potential successors, including strengths and order of consideration.
Formalized standard operating procedures SOPS : A collection of documents, procedures, employee handbooks, and training documentation. Who Should Create a Business Succession Plan Succession plans are commonly associated with retirement; however, they serve an important function earlier in the business lifespan: If anything unexpected happens to you or a co-owner, a succession plan can help reduce headaches, drama, and monetary loss. You should consider creating a succession plan if you: Have complex processes: How will your employees and successor know how to operate the business once you exit? How will you duplicate your subject matter expertise? Employ more than just yourself: Who will step in to lead employees, administer human resources HR and payroll, and choose a successor and leadership structure?
Have repeat clients and ongoing contracts: Where will clients go after your exit, and who will maintain relationships and deliver on long-term contracts? Have a successor in mind: How did you arrive at this decision, and are they aware and willing to take ownership? The 5 Common Types of Succession Plans There are several scenarios in which a business can change ownership. Here are the five most common types of small business succession plans in detail. Selling Your Business to a Co-owner If you founded your business with a partner or partners, you may be considering your co-owners as potential successors. Potential Drawbacks A buy-sell agreement with a co-owner requires a lot of cash kept on-hand. Passing Your Business Onto an Heir Choosing an heir as your successor is a popular option for business owners, especially those with children or family members working in their organization.
Some steps you can take to pass your business onto an heir smoothly are: Determine who will take over: This is an easy decision if you already have a single-family member involved in the business but gets more complicated when multiple family members are interested in taking over. Provide clear instructions: Include instructions on who will take over and how other heirs will be compensated. When business owners decide to cash-out or if death makes the decision for them , a set dollar value for the business needs to be determined, or at least the exiting share of it. This can be done either through an appraisal by a certified public accountant CPA or by an arbitrary agreement between all partners involved.
If the portion of the company consists solely of shares of publicly-traded stock, then the valuation of the owner's interest will be determined by the stock's current market value. Once a set dollar value has been determined, life insurance is purchased on all partners in the business. In the event that a partner passes on before ending his relationship with their partners, the death benefit proceeds will then be used to buy out the deceased partner's share of the business and distribute it equally among the remaining partners. There are two basic arrangements used for this. They are known as "cross-purchase agreements" and "entity-purchase agreements. These agreements are structured so that each partner buys and owns a policy on each of the other partners in the business.
Each partner functions as both owner and beneficiary on the same policy, with each other partner being the insured. Therefore, when one partner dies, the face value of each policy on the deceased partner is paid out to the remaining partners, who will then use the policy proceeds to buy the deceased partner's share of the business at a previously agreed-upon price. The partners want to ensure that the business is passed on smoothly if one of them dies, so they enter into a cross-purchase agreement. The obvious limitation here is that, for a business with a large number of partners five to ten partners or more , it becomes impractical for each partner to maintain separate policies on each of the others.
There can also be substantial inequity between partners in terms of underwriting and, as a result, the cost of each policy. There can even be problems when there are only two partners. Let's say one partner is 35 years old, and the other is 60 years old — there will be a huge disparity between the respective costs of the policies. In this instance, an entity-purchase agreement is often used instead. The entity-purchase arrangement is much less complicated. In this type of agreement, the business itself purchases a single policy on each partner and becomes both the policy owner and beneficiary.
Upon the death of any partner or owner, the business will use the policy proceeds to purchase the deceased person's share of the business accordingly. The cost of each policy is generally deductible for the business, and the business also "eats" all costs and underwrites the equity between partners. Creating and implementing a sound succession plan will provide several benefits to owners and partners:. Proper business succession planning requires careful preparation. Business owners seeking a smooth and equitable transition of their interests should seek a competent, experienced advisor to assist them in this business decision. American Bar Association.
Partners Advantage Insurance Services and their representatives do not give tax or legal advice. Accordingly, any tax information provided is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Discussions of the various planning strategies and issues are based on our understanding of the applicable federal income, gift, and estate tax laws in effect at the time of publication. Your clients are strongly encouraged to work with and consult with their tax advisors and attorneys. This is a search field with an auto-suggest feature attached.
There are no suggestions because the search field is empty. Top 4 Succession Options Producers Can Share with Business Owners Posted by Bill Jackson J. Long Term Installment Sales A long-term installment sale was a traditional approach to employees buying a business. A management team that is capable of operating and growing the business without your involvement Stable and predictable cash flow. Good prospects for future prosperity and growth. The growth of the company should be described in detail in a management prepared business plan. A solid tangible asset base, such as accounts receivable, inventory, machinery and equipment.
Hard assets make it easier to finance the acquisition through the use of debt, but service companies without significant tangible assets can obtain debt financing, albeit at higher cost. Employee Stock Ownership Plan An Employee Stock Ownership Plan ESOP is a tax-qualified retirement plan that must invest primarily in the stock of the company. Modified Buyout Plan This plan works best for most business owners who want to: Transfer their businesses to key employees. Motivate and retain key employees; and Receive full value for their businesses and tie key employees to the company.
This is done by making it economically rewarding for key employees to stay with the company. The initial purchase price will be paid in cash. The plan also includes a two-phase sale of the business. Initially, five percent will be owned by each buyer. For purposes of the initial buy-in and any future repurchases of that stock, the value of the stock is based on a valuation with minority and other discounts provided by a formal valuation. A lower initial value is necessary in order to make the purchase affordable to the employees as well as to provide them an incentive to remain with the company. Benefits to Employees Even though the key employees will not receive voting stock, there will be significant benefits to them in purchasing non-voting stock including: Enjoyment of actual stock ownership in the company, and receiving any appreciation in the stock.
Participating based on their stock ownership in any distributions made by the company. Receiving fair market value paid by a third party for their percentage of stock if the company were to be sold to a third party Participating more directly in day-to-day operating decisions Initially be appointed as directors to serve under the terms of the bylaws on a guaranteed basis Participating in determining which if any additional key employees will be offered stock out of the 40 percent pool. Ongoing purchase payments can be made by the key employees using bonuses and earnings from the company.
Posted by Bill Jackson J. CLU on Wed, Apr 03, PM. The business market can be one of the most lucrative but under served segments for financial professionals. One of the most difficult scenarios business owners face is the solely owned business. Without another major owner to participate in a traditional buy out, many businesses end up being liquidated at little value with a negative impact on the employees. Assuming the business has some capable key employees or can attract them, all is not lost. Business owners can choose from one of four common options. A long-term installment sale was a traditional approach to employees buying a business. After agreeing on a value the employee or employees agree to buy the business over a period of seven to ten years.
The former owner holds a promissory note with installment payments over a seven to ten year period with a reasonable interest rate, signed by the buyers. The note is secured by the assets and stock of the business and the personal guarantee and collateral usually residences of the buyers. This is the least secure option. This structure can be an ideal way to reward your key employees, position the company for growth, and minimize or eliminate ongoing financial risk. To effectively execute a leveraged management buyout, the business should possess the following characteristics.
An Employee Stock Ownership Plan ESOP is a tax-qualified retirement plan that must invest primarily in the stock of the company. In the context of selling at least part of the business to the key employees, the ESOP is used to accumulate cash as well as to borrow money from a financial institution. Key employees will likely own a significant part of that stock because ESOP allocations to participants are based on compensation. Typically, however, key employees will want more than indirect ownership. They will want to control the company and purchase a controlling minority interest in the company. There can be significant tax advantages with this approach. It works best with stable long term employee groups.
Even though the key employees will not receive voting stock, there will be significant benefits to them in purchasing non-voting stock including:. Each key employee purchasing stock will enter into a stock purchase agreement. The agreement with the company would provide for the repurchase of stock in the event of death, long-term disability, or termination of employment of each party to the agreement. An entity type of agreement is most suitable for this strategy. This plan needs a backstop and a way for the key employees to make the final completing purchase payments. The backstop could be provided by permanent life insurance on each party to the agreement, which would complete the sale if a party to the agreement dies prematurely.
If the policies are permanent and smartly funded, tax free cash value via policy loans could be used to complete the sale at the end of the installment period. The entity style of buy sell agreement provides an additional element of security to the original business owner, because the business owns the policies that are being used to fund the agreement completing stock redemption. Look to your affinity groups or your current book to spot prospects who own small to medium sized businesses. Whether they are solely owned or have several owners, business owners are vitally concerned about succession options for their businesses.
Schedule a call to get started in this exciting market and for additional concepts to share with your clients. Tags: practice management. This content is for informational and educational purposes only and is not designed, or intended, to be applicable to any person's individual circumstances. It should not be considered as investment advice, nor does it constitute a recommendation that anyone engage in or refrain from a particular course of action. Partners Advantage Insurance Services and their representatives do not give tax or legal advice.
Accordingly, any tax information provided is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Discussions of the various planning strategies and issues are based on our understanding of the applicable federal income, gift, and estate tax laws in effect at the time of publication. Your clients are strongly encouraged to work with and consult with their tax advisors and attorneys. This is a search field with an auto-suggest feature attached. There are no suggestions because the search field is empty. Top 4 Succession Options Producers Can Share with Business Owners Posted by Bill Jackson J.
Long Term Installment Sales A long-term installment sale was a traditional approach to employees buying a business. A management team that is capable of operating and growing the business without your involvement Stable and predictable cash flow. Good prospects for future prosperity and growth. The growth of the company should be described in detail in a management prepared business plan. A solid tangible asset base, such as accounts receivable, inventory, machinery and equipment. Hard assets make it easier to finance the acquisition through the use of debt, but service companies without significant tangible assets can obtain debt financing, albeit at higher cost.
Employee Stock Ownership Plan An Employee Stock Ownership Plan ESOP is a tax-qualified retirement plan that must invest primarily in the stock of the company. Modified Buyout Plan This plan works best for most business owners who want to: Transfer their businesses to key employees. Motivate and retain key employees; and Receive full value for their businesses and tie key employees to the company. This is done by making it economically rewarding for key employees to stay with the company. The initial purchase price will be paid in cash. The plan also includes a two-phase sale of the business. Initially, five percent will be owned by each buyer. For purposes of the initial buy-in and any future repurchases of that stock, the value of the stock is based on a valuation with minority and other discounts provided by a formal valuation.
A lower initial value is necessary in order to make the purchase affordable to the employees as well as to provide them an incentive to remain with the company. Benefits to Employees Even though the key employees will not receive voting stock, there will be significant benefits to them in purchasing non-voting stock including: Enjoyment of actual stock ownership in the company, and receiving any appreciation in the stock. Participating based on their stock ownership in any distributions made by the company. Receiving fair market value paid by a third party for their percentage of stock if the company were to be sold to a third party Participating more directly in day-to-day operating decisions Initially be appointed as directors to serve under the terms of the bylaws on a guaranteed basis Participating in determining which if any additional key employees will be offered stock out of the 40 percent pool.
Ongoing purchase payments can be made by the key employees using bonuses and earnings from the company. Once they have acquired a significant minority interest, loans may be available through private or banking sources to continue the buyout. Features of the Stock Purchase Agreement Each key employee purchasing stock will enter into a stock purchase agreement. Ensuring Completion of the Sale This plan needs a backstop and a way for the key employees to make the final completing purchase payments. FOR PRODUCER USE ONLY. NOT FOR USE WITH CLIENTS. Subscribe via Email. How do you stack up to other financial professionals? Other financial professionals were interested in Wow Your Prospects with Videos: A How-To for Financial Professionals.
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How to Create a Business Succession Plan,Who Should Create a Business Succession Plan
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American Bar Association. The last thing you want is to reach your retirement date, or triggering event, and find that your chosen successor has no way to afford your business. He recently spent six years leading a team of small business financing professionals, facilitating the deployment of critical capital to over 9, small businesses across the US. Small businesses with several employees and complex financial structures. Subscribe via Email.
Investopedia is part of the Dotdash Meredith publishing family. Even if they are, having enough liquid cash on hand is another challenge, business succession plan buyout option. Look to your affinity groups or your current book to spot prospects who own small to medium sized businesses. These agreements are structured so that each partner buys and owns a policy on each of the other partners in the business. If the portion of the company consists solely of shares of publicly-traded stock, then the valuation of the owner's interest will be determined by the stock's current market value. Small companies few employees and simple financial structures seeking long-term mentorship.
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