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Business Succession Planning for Closely Held Businesses: 7 Key Steps
Thursday, December 7, 2017

Written by: Jeffery G. Stagnaro, Business Law Attorney and Jeffrey B. Stagnaro, Law Clerk

Succession planning, small businesses, Closely Held Businesses, privately held business
Closely held businesses are substantial drivers of the economy.
  Family owned businesses, for example, account for roughly 50% of GDP in the US.  Yet, only 30% of family owned businesses transition successfully to the second generation.  Among other factors, inadequate or entirely absent business succession planning makes it difficult for closely held businesses to achieve long-term sustainability.  While there is no single solution to effective succession planning, below are 7 steps business owners can take to position their companies for successful transitions.

  1. Identify Successors (Ownership and Management).  The best way to ensure the long-term sustainability of your business when you leave is to hand it off to willing and capable successors.  Be sure to treat ownership and management as two distinct succession matters.  Family-owned businesses, in particular, must be willing to have two separate discussions regarding ownership and management as it will not always be the case that there is a family member with the desire and/or competence to assume management of the business.  Ownership and management are not the same and should not be treated as such.  If necessary, look outside the company for a strategic partner/employee willing to train and eventually buy-in to the company.  Carefully and objectively consider the strengths and weaknesses of potential successors—your succession plan should put the successors in a position to succeed without compromising the success and sustainability of your business.
  2. Retain Key Employees.  Losing key employees—particularly salespeople who have developed industry relationships—can cripple a business during the transition period.  Identify which employees are critical to the success of the business and implement long-term retention incentives.  Deferred compensation plans, sometimes referred to as “phantom stock plans”, are useful tools to incentivize key employees to remain with the company.  However, make sure you get something in return for the compensation incentives.  Be sure that your key employees are bound by non-competes and non-solicits before extending compensation incentives.
  3. Appoint Board of Advisors.  Understanding that unforeseen events may alter the succession timeline, appointing a board of advisors can be an effective way to ensure a smooth transition of ownership—even if at a time not originally contemplated by the owners.  The board of advisors should consist of trusted individuals with extensive industry experience.  An unforeseen event, such as death or disability of an owner, can be difficult to overcome if the business is not ready for immediate transition.  A well-chosen board of advisors can assist in the stabilization of the business and orderly transition of ownership and management.
  4. Define Valuation Criteria.  Determining the criteria for valuing a departing owner’s interest in the company up-front mitigates potential conflicts later.  Unlike publicly traded companies, the market valuation for closely held business interests are not readily available.  As such, you should identify valuation criteria that accurately reflects the value of your ownership interest. This is where the company’s CPA firm can play a vital role in succession planning, particularly if the CPA firm has CVA’s, certified valuation analysts. There are many approaches to valuation for companies depending in large part on the industry. For example, there may be valuation formulas based on a multiple of earnings, gross revenues, or net book value.  Alternatively, the valuation can be determined based on an independent appraisal of the company performed at the time of buy-out.  Having a good understanding with preliminary discussions on the appropriate valuation method will assist in how best to plan for funding a transition.
  5. Determine Buy-Out Funding.  An unplanned obligation to purchase a departing owner’s interest in the company can be a substantial burden on the company.  It is critical to plan for the source funds and the timing of the buy-out to avoid impairing the company’s ability to conduct business as usual.  Buy-outs are typically “seller financed”, funded through a third party such as a bank, or funded with insurance proceeds in the event of a death or disability.  In a “seller financed” transaction, the successor issues a promissory note to the selling company or owner to satisfy the buy-out obligation.  In such a case, the term of the promissory note needs to be amortized over a long enough period of time so as not to unreasonably impair the cash flow operational needs of the company.  
  6. Consider Estate Tax Consequences.  For owners of closely held businesses, business succession planning should be done in conjunction with estate planning.  Make sure that your succession plan compliments your estate plan in a tax-efficient manner.  For example, reorganization strategies can give you the flexibility to begin reducing the size of your taxable estate by transferring non-controlling and non-voting ownership interests to family members and/or successors without giving up control of your business.  For 2018, the estate and gift tax exemption amount is $5.6 million per person, which is $11.2 million for a married couple, and the annual exclusion amount is $15,000. With marketability and minority discounts available, the opportunity for substantial gifting should not be overlooked.  
  7. Create a Written Plan.  The final and perhaps most crucial step in creating a business succession plan, is to actually put a plan in writing.  Less than a quarter of closely held businesses have a written succession plan.  While business succession may seem to be too distant an issue to compete with the daily demands of building and sustaining a business, taking the time to create a thorough plan is the first step to ensuring the long-term success of your business for generations to come.

At SSP, our business and estate planning lawyers have advised hundreds of business owners on succession planning and designed estate planning strategies for our business owner clients. 

If you’d like to explore this topic further, please contact Jeffrey G. Stagnaro via email or 513-533-2981 Disclaimer: The information you obtain in this article is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until an attorney-client relationship has been established.  


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