You have probably purchased business insurance to protect your business from a variety of threats, such as theft or a natural disaster; however, is your business protected from the impact of your death or incapacity? If not, it needs to be because if something happens to you, all of the time and money you have dedicated to your business could be lost in the blink of an eye. Business succession planningensures that your interest in your business is protected in the event of your death, incapacity, or even retirement.
Every succession plan is as unique as the business it is intended to protect; however, there are some common questionsthat most business owners try to answer within their plan, including:
- If you are incapacitated tomorrow because of a catastrophic accident or debilitating illness, who will take over the immediate day to day control of your business?
- Is it clear to your employees, business associates, and family who will take over in your absence and will they accept that person as their leader?
- Does the individual designated to take over have the legal authority to do so?
- Will your family continue to benefit financially from the success of the business during your incapacity?
- If you become permanently disabled, or retire, who will take over your business?
- Will your business be included in the probate of your estate?
- If your business will be part of your estate, what will happen to the value of your interest in the business if it is sold and how will the value of your interest be determined?
- If your business is a family owned business have you prepared the next generation to take over?
- Have you set up the proper legal structure for the business to facilitate the transfer to the next generation?
- What will the tax implications be for your business should you die?
- Does the business have sufficient liquid assets to cover any tax debt that might be owed when you die?
Estate planning, when done properly, doesn’t just plan for death, but also for the possibility of incapacity. As the owner of a small business or family farm/ranch, planning for the possibility of your own incapacity is crucial. A small business, farm, or ranch cannot function for long without someone at the helm – and that person must have the proper legal authority to operate the business. Imagine if you were injured in an accident tomorrow and became incapacitated. Without an incapacity plan in place, no one would have the legal authority to negotiate contracts for the purchase of supplies nor for the sale of products. Banks, suppliers, customers, government agencies would all be unwilling to continue working with your business without plans in place that contemplate just such a scenario.
One of the most important considerations in a small business is management continuity. Never assume that an adult child or senior employee is willing and able to do so. Even if they are, does he/she have the legal authority and practical capacity to step into your shoes? If not, the business could falter rapidly. Both customers and suppliers can become reluctant to do business with an operation when they are unsure who is running the show. A well thought out succession plan will ensure that a successor is ready to step up and take over should the need arise.
Liquidity is important in any business; however, small to medium size businesses are notoriously short on liquid assets because the value of the business is often tied up in equipment, materials, stock, and other non-liquid assets. This is particularly true if the business is relatively young. Federal and state gift and estate taxes, however, are calculated based on the value of your estate, without regard to whether your estate assets are liquid or non-liquid assets. If your estate lacks sufficient liquid assetsto pay the tax due, assets must be sold to pay off the debt. Selling assets, however, could put the entire operation out of business.
There is no universal time frame within which a business should be passed down; however, if you plan to pass the business down to the next generation you must start the process far enough ahead of time for your business to make a successful transition. If, instead, you want the business to be sold upon your death or incapacity, you must also start planning now to ensure that your loved ones receive the fair market value of your interest in the business when the time comes to sell it.
There are numerous methods you might choose to facilitate the transfer of ownership of your business from one generation to the next. One of the more popular of those methods is to create a Family Limited Partnership (FLP). An FLP allows you to transfer your legal interest in the business to the next generation slowly, over time, while maintaining control over the day to day management of the operation until such time as you are ready to retire. In addition, you may be able to gain tax advantages by using an FLP to transfer interest in your business to future generations.
If you do not plan to pass down your business to the next generation, it is vital to consider what will happen to your business if something happens to you. One option is to enter into a Buy-Sell agreement. A Buy-Sell agreement guarantees that you (or your loved ones) will receive the fair market value of your interest in the business in the event you, or your surviving loved ones, must sell it at a later date. In essence, a Buy-Sell agreement is a binding agreement between you and someone who agrees to purchase your interest in the business in the future for a pre-determined price or using a fixed method of determining the fair market value at the time of the sale to ensure that your loved ones are not forced to sell your interest at a steep discount following your death or incapacity.