Succession planning is not only one of those business buzzwords that every business owner has heard in their lifetime, but thanks to the hit show Succession, also a concept that millions of people have been introduced to through the fictional Roy family, and specifically their patriarch, Logan Roy. But what exactly is “succession planning” in today’s real world? Well, as we like to say in my profession, it depends.
Broadly speaking, succession planning is a process that involves developing an action plan to ensure a company succeeds into the future. Depending on the size of a company, and the goals of the owner(s), this may include preparing for the loss of key leadership individuals, ensuring that loyal employees are rewarded following the sale of a company, or setting up the next generation to take over a family-owned business. A successful succession plan must be tailored towards the goals of the person(s) planning for the future; this is not a one size fits all process.
In large corporations a board of directors will often work directly with the chief executive officer of the company to oversee the ongoing succession planning process. When hiring “C Suite” positions, the directors must consider not only their own personal interests, but also those of the employees and shareholders. Further, as many of these types of companies operate in multiple states and countries, the laws of multiple jurisdictions often need to be considered. These larger plans can involve teams of lawyers, CPAs, and public relations consultants.
While the succession planning process for smaller companies is unlikely to be detailed on by network television, the same issues exist for these companies. Implementing a successful succession plan can sometimes take years. Often, the starting point is a professional valuation of the company. Lawyers and CPAs will help with the necessary documents and tax planning. The best practice is to have as much in place as possible before finding yourself up against the “succession clock” trying to wrap everything up.
Whether you have already created a succession plan, are currently working on one, or have never really put much thought into it, there is a lot for a small business owner to consider. In this article we will: (1) take a look at statistics relevant to small business succession planning; (2) discuss core business planning documents; and (3) learn how proper estate planning goes hand in hand with succession planning for family-owned businesses.
MY BUSINESS IS SMALL. WHY WOULD A SUCCESSION PLAN BE NECESSARY?
Small businesses not only represent one of the largest group of employers in the country, but they also directly impact the country from a monetary perspective. Small businesses represent about 43% of the country’s gross domestic product. These companies were responsible for about $1.3 trillion in exported goods from the United States in 2020. While the vast majority of small businesses may serve an individual niche in society, the statistics demonstrate how vital they are for the economic success of the United States.
Although all business owners constitute a major segment of the economy, most have never created an actual succession plan. One survey found over 63% of surveyed owners report being over 50 years of age, and 30% over 60 years of age. Among the surveyed owners, 55% cited retirement as a motivation for selling, and over 1/3 said that they actually planned on selling their companies within 2 years. But despite these numbers, according to a PwC Family Business Survey done this year, only 1/3 of respondents reported having a “robust, documented and communicated succession plan in place.” What this means is that while many businesses owners are thinking of retirement or are likely to consider it in the near future, they have not setup their businesses to continue to thrive after the owners retire. These owners may have loyal employees they care about, customers that they hope continue to use the products and services of the business, or have a partner that will take over the business. Whether you are in your 20s or your 70s, a succession plan is going to help ensure that you mitigate the unexpected variables that inevitably weave their way into your life once you think it is time to sell and/or retire.
THOSE STATISTICS DON’T APPLY TO ME. I’M YOUNG AND WORK WELL WITH MY BUSINESS PARTNERS. HOW CAN SUCCESSION PLANNING HELP ME NOW?
Small businesses often have more than one owner. Quite often friends and/or co-workers decide to open a business together. They might use an online rapid service to file their articles of incorporation/organization, and perhaps have a generic operating agreement/bylaws drafted, but they have not really thought about much more than how they are going to get their business to grow. Planning for buy-outs and future investors is simply not at the top of their mind.
Questions will eventually start to materialize over time. What if one of the partners wants to sell their interest and move on to something else? What if further capital is needed by the business, resulting in the sale of interest to an additional owner? What if the company has been thriving for 20 years and wants to provide key employees an opportunity to own a share of the business without giving up operational control? These are all questions that can be answered with a proper succession plan. Below is a brief description of two of the core documents that are often part of a succession plan.
Operating Agreement / Bylaws
While not required under Nevada law, when a limited liability company (“LLC”) or corporation is created in Nevada, owners will always want to have an executed operating agreement (for LLCs) or bylaws (for a corporation). These documents outline a company’s financial and operational decisions, including how such decisions will be made, the role of important positions in the company, and much more. It is true that these documents likely do not require provisions answering the above questions for single owner businesses and/or businesses without employees. However, when there are multiple owners and/or employees to consider, these are crucial not only for the day-to-day decisions, but also for the future of the company. Whether the issue is how to incorporate a new investor, replace key leadership in the future, or ensure you maintain operating control after a sale of ownership interest, an operating agreement or bylaws may detail the following issues pertinent to these issues:
Outlining voting requirements among owners prior to the sale or issuance of ownership interest in the company.
Naming the individual(s) who determines whether to make dividend or profit distributions.
Providing the order of distributions in the event that an owner provided a loan to the company, a future capital contribution was made by one owner but not the other, or an owner’s contribution is labor rather than an equal monetary contribution.
Setting forth the procedures for filling the vacancy of a key management figure.
Defining the roles and responsibilities of chief executives, presidents, etc.
Detailing the rights and restrictions of different types of ownership interest (i.e., voting shares of stock versus non-voting shares).
Buy-Sell Agreements / Shareholder Agreements
While there can be overlap between these types of agreements and those discussed above, one of the primary purposes of a buy-sell agreement or shareholder agreement is to set forth the terms of if and how ownership interests are transferred. The transfer of ownership goes well beyond a negotiated sale between partners. An owner may unexpectedly die or become incapacitated. Owners sometimes divorce without realizing that their ownership interest may be subject to community property laws. Sometimes an owner finds personal bankruptcy necessary without realizing the impact it could have on their business partners. A buy-sell agreement or shareholder agreement provide the following information:
Whether an owner may sell their ownership interest to a non-owner third party.
Setting forth which circumstances allow for the company to voluntarily terminate the ownership interest of one of the owners, and if so, under what conditions will their interest be discounted.
How to determine the fair market value of the ownership interest being transferred.
The process for making distributions to the estate, trust, or spouse of a deceased owner, including, but not limited to, the company’s purchase of the ownership interest or the proceeds of an insurance policy purchased by the company on the life of the deceased owner.
HOW CAN I GIVE MY COMPANY TO MY KIDS BUT STILL HAVE ENOUGH TO RETIRE?
This is where a well thought out estate plan can help. Just like the governing documents, your estate plan can set your family and company up for continued success. This goes well beyond simply utilizing a will or trust to name the beneficiaries of your ownership interest. Much can be accomplished with a well thought out plan.
Even a straightforward revocable trust can be powerful. The trust can set forth requirements for your children to obtain a degree, take specific business classes, or even meet with a lawyer and/or CPA prior to assuming operating control of the business after your death. Your trust can remain the owner of the business, receiving any distributions made, and only providing direct distributions to your children upon reaching a certain age, or solely for their health, education, maintenance, and support. Even these easy to incorporate provisions can help ensure that the future leaders of the company (your children) are as prepared as possible to take over outside of any training they may receive as employees of the company.
But your estate plan can go well beyond the aforementioned issues. For a high net worth individual, trusts are often structured to ensure that minimal federal estate taxes are owed after death. During an individual’s life, another strategy is to create a “grantor trust,” that allows the creator of the trust (the “Settlor”) to give or sell assets to the trust to grow for future generations, but rather than the Trust pay its own federal income tax obligations, the Settlor will be responsible for such taxes on their own personal return. If the Settlor in this scenario intends to retire, but needs ongoing cash flow during retirement, rather than gifting the ownership interest to the new trust, the Settlor can sell a portion in exchange for a promissory note. This creative option requires the trust to make the payments set forth in the promissory note but because the Settlor made the sale to a grantor trust, taxes will not be owed on these payments.
These are just a couple of high level options. The biggest point is that whether you wish to have a simple estate plan, or intend to explore the creative options available to you, your estate plan is another tool in properly structuring your succession plan. Succession planning and estate planning are often symbiotic in nature, and ignoring one piece of the puzzle only hinders your ability to implement your goals in their totality.
I DO NOT WANT TO BE AN UNFORTUNATE STATISTIC. HOW SHOULD I APPROACH CREATING A SUCCESSION PLAN?
Most people do not want to be nearing retirement without a plan for the future of a company they built. As discussed in this article, this may involve agreements between you and your partners, or complicated estate planning. But the first step may simply be you sitting down with your family and/or business partners and discussing what you want or need.
Regardless of your specific needs, whether it involves starting from scratch or updating your currently existing estate plan, Solomon Dwiggins Freer & Steadman, Ltd. can help. We have multiple attorneys, myself included, who specialize in helping people develop their succession plan. We also can share our experiences and recommend strategies that will help you accomplish your goals. So please, if you own your own business, at least take some thought about your own personal succession plan. And if you want to discuss some strategies and options in further detail, we are always here to help.