February 23, 2024
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Succession planning critical for business


Lee Schuh

Lee Schuh

Entrepreneurs know that businesses are like children. You know they will leave you at some point in the future, but you really don’t want to think about it.

Small-business entrepreneurs who think of a business as their favorite child too often avoid the important task of exit planning.

It is never too early to plan for the business being transferred. Succession planning should be in the business plan. Like everything else in the plan, it is subject to change. But, as the saying goes, a failure to plan is a plan to fail. Some of you are saying that business plans are passé. Call them continuous improvement plans, if you prefer, as the goal is planning for the future.

The traditional methods of transferring a business include the following: selling it, hopefully at an optimum price; transferring it over time to family members; and retiring from active management to passive status while retaining ownership. It really doesn’t matter which method is originally chosen so long as it is consistent with the business plan.

Certainly, if the plan is to sell in the next few years, attractive financial records are the major objective even though it might mean paying higher taxes. One can go through a business broker and offer potential buyers options to buy. To obtain an optimum price you should have a long period of time available for the planned sale. Quick sales yield less value as the buyers know it must be sold.

If intending to transfer decades from now, I would suggest more of a long-term emphasis such as tax minimization. A good defined benefit plan for the owner that can maximize retirement and reduced taxation of company profits is a winner. Likewise, tax deductible fringe benefits that are beneficial to the owner and family can be used. Jobs for children and other relatives can be used to reduce profits and benefit the family.

Company-owned life insurance on the owner and overhead insurance covers unexpected absences from the owner and allows the company to survive. The business plan should include a replacement should something happen to the owner. Being absent for six months due to cancer or a broken hip can be the death of a business without insurance and a named successor.

For long-term ownership, I have several suggestions. Insurance could be used as a tool for one of the family members to buy out the rest of the heirs. This is especially true if there are several children and only one or two want to be involved in the business. If the business is a small partnership, a limited liability company or a corporation with several shareholders, a buy-sell agreement would be a natural solution.  The business entity could buy the business from the deceased or retiree or the other partners while members or shareholders could purchase insurance on each other for buyout purposes.

There are millions of sole proprietors out there and if they die, the business dies with them leaving nothing for the heirs. Therefore, it is good planning to transition the business to a corporation or limited liability company status. If not, consider a revocable trust ownership of the business allowing the business to continue after death with the alternative trustee taking over.

Finally, consider retaining the ownership of the business and having a management team take over. This is never easy for the owner or the new managers. Conflicts are inevitable. It is necessary for the owner to leave day-to-day management to the team. Serving as the godfather is a more appropriate role for the owner — spending time on the “big picture” and letting the team handle the daily routine. I have found this works best if the owner moves to Leisure Village, Hawaii or some other place where retirement activities can keep them busy most of the time and the business becomes secondary in importance. Just as when children leave the nest, it helps to have new activities to fill your time.

• Lee Schuh is a lecturer in the School of Management at California Lutheran University.