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Business Succession Planning Never Goes Out of Style

Summer 2006Cole Schotz Docket

The tragic events of 9/11 inspired many business owners to pay much greater attention to disaster recovery plans.  Suddenly everyone understood the need for off-site data backup systems and remote information retrieval.  Although there is no assurance that a disaster caused by external forces such as terrorism, fire, flood or malicious mischief will ever strike a given business, there is no doubt that the ultimate “personal” disaster will at some time occur – namely, the death of a principal owner of a business, sometimes quite unexpectedly.  Yet, how many business owners have taken the time to plan for the succession of their businesses after their demise?

Business succession planning is critical for business owners for many reasons.  First, a closely held business is frequently the primary component of a business owner’s wealth.  After spending decades or perhaps a lifetime building up a business, an owner wants to see his family benefit financially from his toil.  Business owners also recognize the impact that their businesses have on employees and their families, as well as on the local economy where the business is located.  While the economic ripple effects will depend upon the scope, location and size of the business, the real impact cannot be denied:  workers and their families depend on the paycheck and benefits received through their employment.  Business owners with children are also concerned for their children’s ability to support themselves and their extended families, whether they work in or outside the business.  Some are also concerned about the legacy to be attached to their name or business after death.  Last, there is often a concern for estate taxes which, if not planned for, can ruin the viability of a business.

What should a business owner do to address these issues?  The first step is to recognize the possible scenarios for business continuation when a business owner is no longer around.  There are five possibilities: 

Family Succession:  A successful business owner often wants his children to follow in his footsteps.  Yet, according to statistics, only 30% of family businesses survive the second generation.  To succeed, the next generation must develop leadership skills; learn how to deal with employees and vendors; understand finance; and know how the business works from top to bottom.  It can take decades to successfully bring the second generation “up to speed” in the business and to allow the children to earn the respect, while minimizing the jealousy and resentment, of other employees.

Sale of the Business to Employees:  If children are not willing or able to step into the business, loyal and capable employees sometimes are eager to do so.  An employee stock ownership plan, or “ESOP”, sometimes can be implemented to enable existing employees to take the helm while funding the buyout of the business owner.

Sale of the Business to Shareholders or Partners:  When starting or buying a business with others, one should always enter into a shareholder (or “buy-sell”), partnership or operating agreement to address the “3 D’s” -- death, disability and disengagement.  Such agreements identify the triggering events which will force or allow an owner to sell his share of the business, and use formulas to determine the amount to be paid for one’s equity.  Having a written agreement in place might also help the business owner feel more at ease because he knows the person or entity who will carry on the business.

Sale of the Business to a Third Party:  This is often the choice of last resort.  No one can ever know if there will be a market for a business whose owner has suddenly died, become disabled, or wants to retire.  Those desperate to sell (for example, the decedent’s heirs who are not familiar with the business) may be forced to accept a “fire sale” price, failing to realize the maximum value of the entity.  Also, even if a market exists, who knows if the business will remain viable after the sale?  Continued success of the business after it has been sold is critical when seller financing is in place.

Sale of the Business through a Public Offering:  While a sale through an “IPO” may be the ultimate dream for a business owner who is willing to sacrifice control in exchange for maximum value, it is never achieved soon after a business owner dies, becomes disabled or retires unless the IPO planning is very far along. 

For anyone with an accurate “crystal” ball, business succession planning is perhaps not necessary.  If someone knows exactly when he or she will die, then appropriate plans can be made.  For others, however, the need for such planning is a constant because of the unknown, and never goes out of style.

 

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