If you own a successful small business that you’ve nurtured over the years, you may want to leave the legacy of its value to your heirs. To do this, you need a sound, well-thought-out succession plan.
One of the greatest values of a successful small business lies in its continued operation after you’re gone, producing perennial profits for your family. So, with family businesses, succession plans often designate as successors heirs who will take over the business’s operation—usually, grown children who have worked in key roles in preparation to eventually take over.
But sometimes, no heirs are interested in doing so. In that case, owners typically either sell the business before retiring or, if key employees are interested in taking over, arrange an earn-out agreement under which these employees gradually buy the business, if bank financing isn’t a viable option.
But what if you die before you retiring? To cover this event, you want your succession plan to address in detail precisely what will happen to the business to sustain cash flow and avoid confusion, business interruption or other delays that can devalue it, reducing the total amount that your heirs receive.
A common solution is to have in place an agreement with a firm in the same industry, or another interested party, to take ownership of your business in return for compensation (based on its appraised value and updated intermittently) to be paid to your heirs—typically, your spouse—upon the owner’s death or disability. If done correctly, this method can assure a fair price, and can also spare your heirs the burden of having to sell the business, which can be a lengthy process that can lessen its value.
If you’ve taken on an equity partner, succession plans should cover the terms of your buying out him/her, or vice versa. These plans should also outline the process of what will happen if one partner dies or becomes disabled before retiring and selling to the other. It’s best to draw up such agreements in the partnership’s honeymoon period, when everyone’s happy—before the onset of any conflicts that can fester into discontent or distrust, making it hard to agree on succession issues.
These agreements should specify how to this equity is to be valued, and how its transfer to your spouse–—or your partner’s, in the event of his/her death–is to be funded. Funding options may include life insurance policies with each partner as the beneficiary of the other’s policy, financing from a bank with which the firm has an existing relationship or, in the event of disablement, an appropriate disability insurance policy. (Some of these disability policies pay out proceeds in a lump sum.) Insurance taken out to facilitate succession goals is often referred to as business continuation insurance.
When a small business has multiple partners, succession plans should outline the process for acquiring each partner’s equity from their heirs, and the means of financing these purchases.
All succession plans should be coordinated with your attorney, tax advisor and financial advisor to ensure that any specific concerns are addressed, and to help make sure they work smoothly with your estate plan. These steps should be taken to prevent ambiguities that can end up leaving your heirs a legacy of confusion and unnecessary legal bills.
By planning now for the expected—and the unexpected– with a well-thought-out succession plan, you can protect the legacy of your labors that you’re leaving to your heirs, assuring that they receive this legacy intact and promptly. They’ll most certainly be grateful.
Tim Decker is president of ISI Financial Group (www.isifinancialglroup.com), a wealth management firm in Lancaster, Pa., and a fee-only financial planner (he sells no products).