Last week we recognized the passing of Prince and discussed what impact the lack of a business succession plan might have upon his business empire. This week we’ll cover the elements of a business succession plan. First, it’s important to understand what a business succession plan is, and what it’s not. A succession plan is a way to transfer control and ownership of a business to predetermined key people over time in a way that does not harm current operations. It is generally comprised of a series of documents, including shareholder agreements, buyouts, stock pledge agreements, insurance policies and even your Will and trust documents. These documents all need to be coordinated to carry out your overall plan in a way that reduces confusion and removes the potential for lawsuits at what may be the most perilous time for your business. What you generally want to keep out of your plan are surprises. This isn’t the place to tell junior you’ve always disapproved of his moral compass because surprises lead to conflict, which often results in costly litigation. This is one of those times where Main Street can learn from Wall Street. Just like everyone wants to know Warren Buffett’s successor, your customers, partners, vendors and employees are happiest when everyone knows what to expect.
The core of any business succession plan is to spell out in writing how a change in control is going to impact the operation, and thus success, of your business. While there are lots of options, your choice will most likely be driven by your relationship to the person assuming control. For example, if the business is being left in the hands of a family member, or a trusted existing member of your business, you may want to consider having a stock buy-out that is funded by insurance or through a tax deferred account. This can be accomplished through a separate agreement or it may already even be in place if you have a well thought out shareholder or operating agreement. You can also structure the plan so the business assets can be leveraged for purchase financing, although this carries additional risk. Alternatively, if control is going to a new individual, or business for that matter, the insurance policy doesn’t work as well for obvious reasons. In those cases, we often see earn out agreements where retiring shareholders receive an up-front lump sum followed by a series of payments over time. Often these agreements require the departing owner to help transition clients to the new owner, gradually reducing their role in the company over time. For tax purposes, these deals may take the form of a “sweetheart” consulting agreement or just straight cash payments.
How these deals are structured, and financed depend on multiple factors unique to each business, but they all have some of the same considerations at the planning stage. Does it make sense to have your CPA do regular valuations of your business in case a shareholder wants to leave at some point in time? Should there be limitations on when a departing shareholder can cash out in order to protect the financial condition of the company? Are there key people who should be covered by non-compete agreements as part of any sale? These and other considerations are best discussed with your business attorney long before the succession plan actually needs to be used.