Preparing for the Next Stage
By Barbara Trombley, MBA, CPA, CDFA
Life — and business — can shift in unexpected ways, and an ownership transition can sneak up on even someone who expected to be at the reins for a long time. That’s why it’s good to start preparing for that possibility well in advance.
A succession plan is a vital part of a small business.
Most small businesses were built from the ground up, with a dedicated founder and owner, and it may be very hard for the owner to consider a succession plan. But retirement — or worse, sudden illness or death — can creep up on an owner and create havoc. Without a solid plan, a family may suddenly lose their income or the inheritance that was counted on, or the business may cease to exist.
“Many succession plans are not carefully planned out or are devised as a result of health event. A good succession plan is made when the owner can think rationally and formally devise a sort of buy-sell agreement.”
My personal experience with a succession plan is based on our financial- planning business. My father-in-law did what quite a few financial planners do. He brought my husband (his son) and myself into his business a few years before he retired. My mother-in-law had a bad health scare, and he could see that his years in the business were numbered.
In our case, my husband and I were good candidates to take over the family financial-planning business. We were both graduates of Duke University; I was a CPA, and my husband had recently retired from a first career in major-league baseball. We had the backgrounds and were ready to assume the responsibility of maintaining and growing the business that he started.
The transition wasn’t easy; my father-in-law’s mind knew that it was the best course of actions for his clients, but his heart wasn’t ready to leave. In hindsight, it was a great decision, because his health deteriorated quickly after we took over, and he passed away three years ago.
Many succession plans are not carefully planned out or are devised as a result of a health event. A good succession plan is made when the owner can think rationally and formally devise a sort of buy-sell agreement.
The buy-sell agreement is a legally binding contract that says what will happen if the owner passes away, falls ill, or wants to retire. It will formalize information like the company sales price, the value of each share in the business, and how the sale of the company could be funded.
“Many buy-sell agreements are funded with life insurance; the company or the individual co-owners buy policies on the other co-owners that allow them to buy shares in the company using the proceeds from the insurance after the owner or shareholder’s death.”
Perhaps the simplest example of a buy-sell agreement is if there is more than one owner. The agreement will state that the co-owners can purchase each other’s shares in the event the buy-sell agreement is triggered.
Many buy-sell agreements are funded with life insurance; the company or the individual co-owners buy policies on the other co-owners that allow them to buy shares in the company using the proceeds from the insurance after the owner or shareholder’s death. A term policy is often more inexpensive, but a permanent policy may be more suitable for a longer period of time.
What if you are the only owner? What makes a good succession plan?
A good succession plan will consider the human-resources side of the transition as well as the financial aspects. Do you want to keep the business in the family? Are your family members qualified and knowledgeable about your business? Do they desire and have the heart to keep your business going? Will you choose certain family members over others?
Most businesses do better with a single overall successor as opposed to splitting ownership of the business. It may be possible to appoint different heirs to manage separate departments. Many small-business owners assume their children want to take over. We have heard many stories about family in-fighting or entitled heirs assuming roles that they are not prepared for. Many a business has suffered or failed after a leadership change; a good succession plan will look with an objective view at different family relationships.
Another option to a family succession plan would be to have a key employee buy the business.
The buy-sell agreement could be executed over time, giving the other employees and customers time to get used to the idea, or it can be triggered by an event such as an illness or death of the owner. Of course, not many employees have the funds to purchase a company.
One idea would be to provide seller financing. A loan from the owner to the buyer could provide a stream of income to the owner as he enters retirement. Another option would be outside financing. This would be the best course if the owner desires his funds up front.
In our financial-planning business, we are constantly urged to set up a succession plan. This is mainly to ensure that a properly licensed advisor can quickly service our clients in the event of the death or disability of myself and my husband. Our plan is to set up a buy-sell agreement with another financial advisor that would be triggered in an emergency but fully changeable in case one of our qualified children would like to take over the business for a third generation.
Taking the time to consider the human-resource angle as well as the financial angle can ensure an agreement that is beneficial to all parties involved and ensure the business you have built will last for a long time.
Barbara Trombley, MBA, CPA, CDFA is an LPL financial planner with Trombley Associates Investment and Retirement Planning in Wilbraham; securities offered through LPL Financial; member FINRA/SIPC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Trombley Associates and LPL Financial do not provide legal advice or services. Consult your legal advisor regarding your specific situation.