I’ve had clients who have had to deal with business succession issues and so I invite John L. Wong to provide some insight into what business succession planning is and why business owners should think about it.
As an Orange County Estate Planning Attorney, many of my clients own some form of small business. One of the first questions I ask is: “What’s going to happen to your business when you retire or pass away?” There are two very common responses:
- I’m going to transfer the business to my children; or
- I’m going to sell the business.
I could certainly go through a bunch of hypotheticals to poke holes in these two responses, but often times, if the question was phrased differently, the issue becomes much clearer. “What would happen to your business if you died today?” After some reflection, common responses are:
- The business would fail;
- The business would be taken over by an employee.
So how do ensure your business is transferred under the first set of scenarios instead of the second set? How do you ensure your business is transferred to your intended beneficiaries at the highest possible value? Short answer: Business Succession Planning. Business Succession Planning is the structuring of a plan to transfer of your business to the next generation of owner(s). We assist clients with transferring their businesses in one of three ways:
Sell Your Business Outright to a Third Party
Certainly, the easiest way to transfer your business is to sell it to a third party. We’ve been successful in assisting our clients with both stock sales and asset sales. However, this solution only works if you are ready to sell the business today. Most people are not ready to sell now. Second, you also need to find a buyer with sufficient capital. Depending upon the industry, a simple buyout from a larger company is feasible. Often times clients want to transfer the business to a long-time employee who has the experience but does not have sufficient capital to purchase the business at fair market value. Transfers to employees are typically completed through seller financing.
Use a Buy-Sell Agreement
If you already have a partner, transitioning the day to day operations of the business may be easier. The more difficult issue is how do you ensure your partner buys your interest at fair market value? If you passed away today, what is to stop your partner from taking 100% of the business and not paying your loved ones for your interest? Sure, you may own 50% or more of the company, but your partner could simply start a new business, take your clients, customers, employees, and goodwill if you do not have an agreement in place. The combination of a Buy-Sell Agreement, non-compete and cross purchase life insurance on the partners will ensure an equitable purchase price and sufficient liquidity to pay your beneficiaries. Beyond life insurance, there is also disability insurance to address situations where you are no longer able to work.
Transfer to Your Children Through a Trust
If your plan is to transfer your business to your children in the future, there are a few issues to consider: 1) Are your children willing to take over the business? 2) Do they have the necessary skill and experience to run the business? Although you may hope the answer is yes eventually, if the current answer is no to either question, then temporary alternatives should be considered.
The use of a Revocable Living Trust will allow you to build in contingency plans until your children are prepared to take over the business. For example, provisions can be included in your Trust to allow the Trustee to manage the business until your children become involved in the business.
Choosing the proper Trustee to manage the business is imperative. The Trustee may choose to run the day to day operations of the company or hire the appropriate employees to do so. The Trustee could be your beneficiaries, a close friend or someone currently involved with the business. If you have a business that requires special licenses (e.g. medical or legal practice), you should name a special trustee that is licensed to handle the business until your children obtain the necessary license(s).
If your children choose a different career path or if your children do not obtain the necessary experience, then you need to make sure your Trustee is prepared to run the business until it can be sold for maximum value to a third party.
Ultimately, early business succession planning is vital to the successful transition of your business.
John L. Wong is a Certified Specialist in Estate Planning, Trust and Probate law by the California State Bar. He advises individuals and business owners on all aspects of estate planning, probate, trust administration and asset protection. John also represents beneficiaries and fiduciaries in matters involving trust and probate litigation. With years of big firm experience in estate planning, John provides his clients with the tools and techniques used by the big firms at a more reasonable cost.