A small-family business is a source of great pride for many American families. Almost all families that have a small farm or business would like to keep it in the family if possible. The best way to do this is to create a business succession plan. The following 6 basic questions can lay the foundation for a successful business success plan.
- Why is a business succession plan needed?
If an attorney were to simply ask what one hopes to accomplish in drafting a business succession plan many would state that they wish to transfer the business while paying as few taxes as possible. An attorney can then map out the steps needed to accomplish that goal or any other goal. A major component of a successful business succession plan is the inclusion of future players. For example, you may want to give the majority of decision-making power to one child who has had the most involvement with the business while limiting the power of an out-of-state relative.
- What mechanism should be used to facilitate the business succession plan?
Most people think of a buy-sell agreement when they think of ways to transition a business. But there are other options including outright gifting, including a specific clause in a Will to gradually transition to business and gifting to different types of trusts. The simplest plan is usually an outright gift of the business or a provision in a Last Will and Testament specifying who will receive the business upon the owner’s death. However, be warned, the simplest plan is not always the best plan. Sometimes, the goals of the current and future owner require a more complex plan.
- How will the business transition occur?
All this question is really asking is if you wish to gift the business or sell it to the next generation. In many families, the current owner may feel that their family member has worked or paid into the business enough over the years to illicit a gift. However, if you have multiple children and only one is going to be inheriting the business, a sale may be necessary to prevent hard feelings between siblings. In deciding whether a gift or sale is right for you, consider the effects such a decision will have on the entire family.
- How will the business transition be funded?
If the business will simply be gifted to the next generation this question is largely not an issue. However, this is a vital question to ask yourself in a buy/sell agreement. Typically, this agreement will be funded with life insurance. It also important to consider how the sale will be structured whether it will occur in a lump sum or a whether a payment plan will need to be set up.
- What will trigger the transition of the business?
In answer to this question, think of the “three Ds” = death, divorce and disability. There can be other events that trigger the transition, but these are the big ones to consider. A proper business succession plan will address what triggers the business transition. Most clients have only considered the possibility of transition at death while few have considered the very real possibility that the business owners becomes divorced or disabled and is then unable to run the business. In considering disability, a good business succession plan should also address the possibility of requiring long term care and if part of the business can be used to pay for that.
- What assets does the business own?
The type of assets a business owns directly affects the types of taxes a good business succession plan should avoid. For example, if a business involves real estate with a low cost basis, then the owners may want to structure the succession plan so that new owners obtain a stepped-up basis. This may result in less overall tax because the income tax is realized in the difference between fair market value and the cost basis of the real estate. Knowing what assets the business owns is the first step to tackling tax concerns.
Your answers to the six guiding questions provides general guidance as to how a business transition plan should be structured. Every business that is transitioning from one generation to the next should have a business succession plan in place. Business owners have worked hard to make their business a success and it would be a shame to hinder that success for future generations.