Business Succession Planning

Business owners, CFOs, and others interested in learning more about business succession planning met to learn key strategies from Julius Giarmarco, Partner at Cox, Hodgman & Giarmarco, and Donald Clayton, Managing Director at Clayton & McKervey, P.C. This summary highlights many of the questions and answers covered during the session.

What does a business succession plan look like?

Essentially, it is a straightforward document that addresses the four key elements of a succession plan: 1) identifies a future leader, 2) establishes a timeline, 3) outlines financial and tax implications completely, and 4) addresses required agreements.

What are the biggest obstacles to a successful succession plan?

First, if the succession is to the children of the owner, make sure that active and non-active children are treated fairly. There are several options to ensure this, including a life insurance trust, or creating two kinds of stock. Second, recognize that the business is typically the largest asset in the estate, coming to an agreement that allows the business to move forward, and get cash flowing to the succeeded business owner. The third largest obstacle is Uncle Sam. If there is a taxable estate, factor that in without making Uncle Sam a partner with your family.

What are the most common mistakes business owners make in their succession plan?

The biggest mistake is to not make a plan. If the owner was to die or become disabled, many issues that should have been addressed are not. Another big mistake is failure to implement the plan. The sooner the plan is in place and acted upon, the better the results in terms of exemptions and estate taxes.

What are some effective ownership transfer techniques?

Estate planning is subjective, and each plan is driven by unique circumstances. With that understanding, some ideas of effective techniques include:

• Gifting the business
• Recapitalize the company with generalized voting and non-voting shares. Utilize the lifetime gift exemption of $2 million if married, and $1 million if single
• Sell the business. The advantage is that it doesn't flag the IRS, and the owner may get fair value for the business and money out for retirement. It also treats all of the children equally. The disadvantage is it is not tax efficient
• Bargain sale is also an option, involving part gift and part sale of the business
• For large estates or large businesses, an effective way to transfer an S Corp or LLC is a Grantor Retained Annuity Trust
• The hottest way currently to transfer a business is a sale to an Intentionally Defective Trust

What are some techniques to keep key employees before, during, and after the transition?

Most key employees want stock or ownership. The problem is the employee will then have phantom income and will have to pay taxes on the stock. A better way is to pay the employee more than any other employer. The best way to keep an employee is an unsecured promise, otherwise known as golden handcuffs. This is a benefit agreement not payable until specified terms such as retirement, X years of service, disability, or death have been met. Another way is a phantom stock agreement, which can defer current tax costs and allows growth based on the future value of the business. It is an incentive to grow the company and can be funded with life insurance. An ESOP is also a possible solution.

How can the next generation of family members or key employees afford to buy the owner/parent out?

They may go to an outside equity firm that will invest and bow out in 5 - 7 years. Or, a loan may be secured. Financing can be complicated, and it is very important to start early.

What about timing?

Start as soon as possible. It takes time to get all parties comfortable with the terms and to set up transfer agreements. There are many ways to structure and minimize tax implications, and a thorough exploration is needed. The succession planning process is generally a 3 - 5 year window.

What is the key to success for the generation taking over the business?

The owner/parent needs to invest in grooming the successor. In addition to the technical side of the business, skills in marketing, human resources, and technology are needed to run the company. Several organizations can help in this area, such as YPO (Young Presidents' Organization) and TEC (The Executive Committee).

How does a parent separate the emotional issues inherent in succession when several children with interest are involved?

Retain a third party facilitator or business coach. This person will evaluate and run the discussion from a business standpoint and take the edge off of the emotional issues.

This summary is an overview of the key issues discussed during the session. For in-depth discussion, please contact Julius Giarmarco of Cox, Hodgman & Giarmarco at 248.457.7000 or jhg@disinherit-irs.com, or Donald Clayton of Clayton & McKervey, P.C. at 248.208.8860.