If you are a co-owner of a family business, it is important to consider what will happen to the company if something happens to you. If you do not have a succession plan, then your heirs and/or co-owners could face significant financial and legal problems which could irreparably damage the business.
Why Do You Need a Succession Plan?
In many family businesses, owners are very active in the day-to-day operations. As a result, retirement disability, and death can have a substantial impact. Owners should plan for such events to help ensure continuation of the business. Without a succession plan, disputes can arise among co-owners and heirs over operational control of the business, valuation of the business, costs to buy out owners who want to leave and other issues.
The goal of a succession plan is to outline what should happen to the business, including who can receive shares, what rights they have, and how shares will be valued (and paid out) to those not part of the business. In developing a plan, the interests of existing owners and successors must be considered. Existing co-owners are typically concerned about the addition of new owners to the business and/or the prospect of buying out such individuals. Those inheriting shares may prefer to be actively involved in the business, be passive shareholders, or simply sell their interest. These issues must be discussed and resolved in the succession plan in order to avoid problems.
What Documents Do You Need as Part of Your Succession Plan?
Once a succession plan is developed, various legal documents will be needed. A company’s partnership or shareholder agreement should set forth what happens when a partner or owner leaves the business, whether by death, disability, or voluntary departure. The part of the agreement that addresses this issue is called a “buy-sell agreement.” A buy-sell agreement can be a stand-alone agreement, but more commonly, is part of the ownership agreement.
What Issues Should Be Considered in Your Succession Plan?
Most succession plans provide that either the remaining owners or the business will buy the departing owner’s interests. However, there are issues which must be addressed, including:
- How will shares be valued? There are different valuation methods which may be used (ex. fixed price, book value; multiple of business earnings; third party appraisal, etc.)
- Who may buy the departing owner’s (or heir’s) shares? The owners or the company may be required to buy, or they could just have an option to purchase the shares.
- How will the owners/company pay for the shares? Money can be set aside by the owners for this purpose or life insurance may be purchased with the proceeds designated to pay heirs for their share of the business.
The most effective plans do not decide these issues in isolation. Succession planning should take a holistic approach incorporating information from different types of advisors. For instance, accountants can calculate the value of the business and provide guidance regarding the most tax efficient way to transfer the business. Insurance professionals can assist in selecting and structuring life insurance to pay for the buyout as well as determine who should own the insurance policy. Attorneys can determine the best structure for the deal (redemption vs cross-sell agreement) and payment terms, and execute all estate planning, corporate, and employment-related legal documents.
A good business owner should plan for succession in order to protect the company and those who rely on it from financial and legal problems. If you have a family business, contact us for a consultation.