Succession Planning: Do You Know Your Options?

Tim McDaniel | November 15th, 2010

Are you actively planning a transition for the business you worked so hard to build? The majority of North American businesses are family-owned, yet just about 30 percent make it to the second generation. Even fewer reach the third generation. As more and more business owners prepare to retire, more and more businesses will face the issue of succession – whether they are prepared or not. This article discusses the third in a series of tips to help family-owned businesses begin the succession planning process.

In our previous articles, we discussed the decision to begin a succession plan and the important second step of knowing the value of your business. The third step in this planning process is reviewing the options available for your succession business transition.

Owners of closely held businesses who are considering making a transition for the future of the business face a number of options. It is important to keep in mind that the best option for your business will depend on your goals and what is most important to you when the transition is completed. For some people, seeing the business continue successfully is extremely important. For others, it means providing a legacy that can continue in the next generation of the family. For still others, receiving a maximum price for the business that will allow the business owner to achieve an optimum retirement lifestyle is the goal.

Giving It Away

Gifting interest in the business is a popular option for business owners whose top priority is ensuring the continuation of the business through family members. The actual transition of the company can include gifting all or part of the interest in the business to family members or employees, selling the company to family members or employees or a combination of both.

The advantage to gifting the business is that the legacy of the business continues. However, the disadvantage to this method is that the transfer of the business results in less cash. If you have great retirement needs, you’ll want to start retirement planning earlier in the transition process. The estate tax is another obstacle that can impede gifting a business.

If gifting interest in your business is a goal, this is one time when today’s discounted business values can be a benefit. With a lower current value of your business, now is a great time to gift interest in the business. You’ll be able to gift a greater percentage of ownership with less tax impact to the recipient than during times when business values are higher.

Employee Purchase

If you want to continue the legacy of your business but you have no family to transition it to, an Employee Stock Ownership Program (ESOP) can be a practical solution. This option ensures the continuation of the business and provides employees with a greater interest in its success – as owners. The disadvantage is that it can be costly to implement, and subjects the ESOP to IRS and Department of Labor regulations that are designed to make sure participants are treated fairly during the purchase. It can be a very effective option in many situations, however.

Selling Out

Another transition option is for the business owner to sell the business outright to either a financial or strategic buyer. If the business attracts a financial buyer, chances are greater that the business will continue in its present form with a new owner. With a synergistic or strategic buyer, however, the business might be purchased by a supplier, competitor or other ancillary business in the marketplace. After the purchase, a strategic buyer will look to decrease duplication, which often results in cutting jobs in areas such as administration. As a business is folded into a strategic purchase agreement, differences in culture can emerge that can be difficult for the “old” business employees to adapt to. The business owner would receive the maximum price from a strategic buyer, however.

Stepping Away

More and more business owners today are maintaining an interest in their business but walking away from the day-to-day duties. At this time when business values are down, many business owners smartly see that by the time they sell their business and pay taxes on it, their return on their investment if they sell now is not as great as it might be. As a result, many of them are bringing in a professional management team, allowing the owner to continue to receive economic benefits from the business while leaving the headaches to someone else.

No Plan Can Mean Liquidation

If you don’t have a plan for the transition of your business, the final result can mean liquidation of the business and its assets upon your death. This often results in the lowest value for the business and can have a devastating effect on employees.

In my next post, I’ll discuss assessing your company’s current position and how it relates to your goals and desires and those of your family.

For additional information about succession planning for your business, please talk to your accounting professional.

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