Best Practices for Small Business Succession Planning

Jul 15, 2019Business, Business Consulting

If you intend to name a family member to succeed you in running your company, you have some advantages. The person you name (probably your son or daughter, son- or daughter-in-law) is someone you can identify easily, without an extensive search. You know the person’s capabilities and shortcomings; he or she likely works for the company now, so you have a good idea of how well the future owner will do. That said, passing on your company to a family member can pose problems. Intra-family dynamics should be considered, which may not be the case if your successor is an outsider. Moreover, there are several methods of relinquishing ownership, all of which may be closely scrutinized by the IRS.

SEEING THINGS CLEARLY

Designating a family member as your successor can raise emotional issues. Does your son really want to run your business, working the long hours you have always put in? Is your daughter truly eager to jump off the partner track at her law firm to take charge of your company? Be honest with yourself, even if it leads to painful conclusions.

Example: Terri Allen realized her two sons did not get along with each other, but she thought this would change as they grew older. Instead, their mutual animosity continues and they are competing with each other to replace their mother as CEO of Allen Enterprises. Facing reality, Terri concluded a 50-50 ownership solution would ruin her successful company. Thus, she is dividing the company into two firms, along product lines, so each son can be the sole owner of his own business in the future.

PLAYING FAIR

If you have more than one child, it is often the case that one will be the obvious successor, while the others will have different careers. Passing on ownership to all the children and leaving one to run the company can lead to strife: the operator may feel like he or she is working to enrich siblings and the outside owners might second- guess business decisions. Naming the child who will manage the company as the sole owner may make sense, from a business perspective, but it also can deprive the others of a valuable asset. In such cases, it may be desirable to equalize the inheritances.

Note: If you are married, your estate plan also should provide for a surviving spouse.

TRANSFER TACTICS

Your estate plan also should focus on the method you will use to keep your company in the family. Broadly, here are your options:

  • Sell it. This mode has the obvious benefit of providing you with income in retirement, enabling you to enjoy the fruits of building the business. Coming up with enough cash for the buyout may be difficult for your younger successor, so it might be necessary to arrange financing or an installment sale so payments will come from future company earnings, in some manner.
  • Give it. Another option is to transfer some shares to your successor during his or her lifetime. Gift tax may be avoided or minimized by using discounts for fractional interests in the company while ownership might be motivational. On the downside, such gifts can reduce the income you will get from the business and you should have a strategy for dealing with other children.
  • Leave it. You can simply hold onto the company until you die and bequeath it to your successor. This approach allows you to remain in control and perhaps receive income from dividends once you stop working. A lack of ownership, though, might discourage your chosen successor and lead to that person’s leaving for another opportunity.

No matter which of these methods you choose, the IRS may challenge the valuation involved. A below-market sale, for example, could be recast as part sale and part taxable gift. Thus, having a reliable valuation of the company should be part of your all-in-the-family succession plan. A sophisticated approach might involve a mix of selling, giving, and leaving your business to a younger relative. Tactics such as retaining income-producing shares while transferring operational control may be appropriate.

Smith Schafer offers succession planning services designed to help Minnesota businesses create and execute a successful transition strategy. Whether you need help creating a succession plan or assistance with implementing various stages of the plan, our professionals can guide you.

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