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Successful Business Succession

Published
Jan 27, 2025
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At the 59th Annual Heckerling Institute on Estate Planning, Thomas Abendroth of   ArentFox Schiff outlined the “Seven (not so) Secret Ways to Successful Business Succession.” It can’t be understated how important having a well thought out business succession plan is to not only the continuity of your business, but also for the financial health and wellbeing of your family.  

1. Convince the Client There is No One Solution 

There is no magic solution, no one best strategy for all business owners. While there is no one solution, business succession options generally fall into two broad categories: internal transfers and external transfers. 

Internal transfers could be considered any one of the following: 

  • Gift of business interests to family members or trusts 
  • Sale of business interests to family members or trusts 
  • Sale to key employee or management team 
  • Employee stock ownership plan (ESOP) 

Often when business owners are considering an internal transfer, they may not be looking to get maximum value for their business. Instead, they may be looking for ideas and strategies that allow them to effectively and efficiently transfer the business to the desired internal parties. Business owners may also be looking to transfer non-voting interests or minority interests in their business, utilizing valuation discounts to help facilitate the desired transfers. 

External transfers could consist of any of the following: 

  • Sale to a third party, including a competitor or strategic partner 
  • Sale to a private equity firm 

Conversely, if a business owner is considering a sale to an outside third party, they are often looking to maximize the value of their business. Business owners should be aware of the due diligence process, as well as the information-gathering requests that prospective buyers will make. This often is a time-consuming and time-sensitive process. Knowing in advance what prospective buyers may be looking for, business owners can proactively plan accordingly. 

It’s important to explore both internal and external transfers during the succession planning process. Business owners may prefer one type of transfer today, only to change their opinion tomorrow. 

2. Understand the Client’s Business and How It Is Valued 

As an advisor to your client, spend the time to learn the history and hear the story about the business. It is extremely important to understand not only how the business was started and the growth that it has had, but also the clients/customers the business serves and industry that the business is in. Is the business in an industry that is capital-intensive? Is the industry or client base growing rapidly? Who are the competitors? That knowledge and background could help to shape what solutions or options might be the best fit for that business and the owner.  

You also need to understand not only what the current value of the business is today, but also what value would the business owner need to walk away from the business and sustain the lifestyle they want to have in retirement. There’s a chance that today’s current value of the business and what the owner needs to walk away with are the same. Fantastic! Unfortunately, those two numbers are often not the same and may be significantly different. You need to not only understand what the gap is between those two numbers, but also understand how you are going to close that gap.  

An important step in this process, which is often skipped or not completed, is having the business owner do some personal financial planning and cash flow modeling. Understanding what the business owner needs in retirement is particularly important in helping to close the gap in the business value. It will help to provide clarity around where the time, energy, and efforts need to be spent by the business owner and the company. 

3. Separate Control from Equity 

Business owners need to understand the difference between ownership and leadership of the business. Business owners may want to transfer the ownership/equity of the business to family members, but they may want to keep the ongoing leadership and management of the business with key employees or the existing management team. 

Separating ownership and leadership of the business comes with a bevy of issues. How does one compensate and retain key employees who are needed to run the business, but don’t have any ownership of the company? How does the business juggle the simultaneous request to draw equity out of the business by family members with the need to continue to grow the business? 

Another consideration is whether the business is properly capitalized. Does the business have voting and nonvoting interests, or does it need to consider a recapitalization? Business owners may be ready to start transferring nonvoting interests to the family members or trusts, but they may not be ready to give up control of the business quite yet. There are several income, estate, and gift tax considerations that business owners need to look at when transferring nonvoting interests and retaining voting interests.  

4. Review Shareholder Agreements and the Impact on Valuation and Planning

The first question to ask business owners is if they have a shareholder agreement and a buy-sell agreement. These agreements are important because they help to lay out rights, obligations, potential value, and a market for the business interest to be transferred.  

Mr. Abendroth noted that buy-sell agreements are used primarily to achieve non-tax goals, including the following items:  

  • Control – giving the owner or company a right of first refusal to purchase shares or accelerate the purchase or redemption of a deceased owner’s interest in the business. The agreements may also establish who eligible holders of the business interest could be. 
  • Liquidity – the buy-sell agreement can create a market for the business owner’s interest, providing a venue to turn the business interest into cash. 
  • Planning – the buy-sell agreement provides a plan on how the repurchase of the business interest under the agreement will be funded. Knowing these steps can help to provide clarity for that business owner, which may assist in their personal financial and tax planning. 
  • Preservation of Tax Benefits – the buy-sell agreement puts restrictions in place meant to protect tax benefits of the business. For instance, the buy-sell agreement for an S corporation may limit and prohibit transfers of the stock to a party that is not a permissible shareholder of an S corporation. 

There was an important tax case that occurred during 2023, Connelly v. United States No. 21-3683, 131 AFTR 2d 2023-1902 (8th Cir. 2023). The case addressed business valuation considerations for buy-sell agreements that go beyond the scope of this article.  

5. Get In on the Ground Floor When You Can 

When clients reach out looking to discuss starting a new business, it is an extremely exciting time in their lives. They often have an idea and see an opportunity for starting this new business. While helping them set up and structure this new business, we also should be asking questions about how they plan to exit the business.  

How long to do they plan to keep or run this business? Do they plan exit the business in the next five years, or do they hope that the business will be around for multiple generations? Discussing the potential answers to these key questions at the beginning of the business formation and planning process will only help to benefit the client. Flexibility is key to business owners, leaving more exit planning options on the table for them. It’s never too early to start the succession planning process. 

6. Plan Well Before the Sale 

Speaking of ‘it’s never too early to start the succession planning process,’ business owners need to consider their exit strategy well in advance of any potential sale. When business owners reach out to tell us that they just received a term sheet or letter of intent (LOI) from a potential buyer, the list of options and strategies that could have been utilized shrinks substantially.  

We get excited when business owners let us know that they are considering a sale of their business in the next two-to-five years. That gives all of us the benefit of time to consider, review, and model several items, including, but not limited to, gift and estate planning strategies, and charitable planning considerations. The more time that we have to properly plan for the sale of the business, the higher the likelihood that we’ll be able to develop and implement a plan that will provide a greater benefit for the business owner and their family. 

7. Do Not Lose Sight of the Non-Tax Planning 

It’s always easy to focus on the tax impact of selling or transitioning a business. Business owners often wondering “What am I going to net, after taxes, from this sale/transition?” While we can model and illustrate various scenarios and strategies and the net after-tax cash impact of each, if a deal does end up falling apart, it often is for non-tax reasons. 

Business owners often don’t spend enough time thinking about how they are going to spend their time after transitioning the business. They spend so much of their lives putting their blood, sweat, and equity into growing the business that they often don’t think about what they are going do next. They also know and understand how important their employees and community have been to the success of their business, but don’t know if the next owners of the business will treat the employees and community the same way. Encourage business owners to spend time considering these non-tax items and goals as well. Time spent defining some of these non-tax goals will only help to provide overall clarity for the business owner.  

Understanding that 100% of business owners one day won’t be the owner anymore is important. Whether this transition is voluntary or involuntary, it’s important to not only have a plan in place that will help protect both the family and the business; you should also be checking the health and viability of that plan early and often. 


Heckerling

The Heckerling Institute offers practical guidance on today’s most important tax and non-tax planning issues, including planning challenges and opportunities. We’ve aggregated blog posts from highlight sessions here, to share our insights with you.

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Derek M. Dockendorf

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