Business Succession Planning

by Victor G. Butcher, CPA, LUTCF

"If you do not think about the future, you cannot have one."
John Galsworthy, Nobel prize winning novelist

I once received a letter from a company in Dallas that specialized in continuing professional education for attorneys and accountants. Due to the death of the owner, the company would be closing by the end of the year and, for now, will staff just enough people to grade the exams and return them to their remaining customers. The letter went on to say that this company had been in business for almost 30 years and appreciated our business.

Everyday, another established business ceases to exist, due to the death or disability of the key person, which is usually the founder and owner. Everything that this person gave up in order to make the business a success becomes meaningless at this point. A little business succession planning at various stages of the business' growth would have allowed the company referenced above to stay in business, and probably even grow to greater heights.

Let's look at what is to be gained by business succession planning:

• Effective business plans;
• Resolutions of family disputes;
• Improve communication between generations;
• Smooth succession planning;
• Commitment to future success; and a
• Happier work environment.

Effective Business Planning

The owners of closely-held businesses have strong emotional ties to their companies. They are justifiably proud of the company's accomplishments and want their families to continue to benefit from this success. But, despite these hopes and dreams, few business owners have given a great deal of thought to what will happen to the business when they die or what they want to happen to the business when they die. Also, thought must be given to how the company will survive if the key owner does not die, but may be suffering a "living death," that is, a long-term disability. While many business owners have some vaguely defined notions about passing on their business to a family member or perhaps selling it, they typically have not explored all of the legal and financial options available to achieve an effective business plan.

Plan for Long Term Disability. If the owner suffers a long-term disability, which renders them unable to make astute business decisions, a plan must be formally in place so that all remaining key people and family members know who is in charge of the decision making process.

Many insurance companies sell individual plans as well as group disability income plans to take care of individuals whom may become disabled due to a long-term illness or injury. Many companies use a combination of group and individual insurance policies so that their personnel and owners can start receiving payments sooner and longer.

Care must be taken prior to an employee's disability on whether the premiums are paid by the employee or employer. If paid by the employer, payments received by the disabled employee are taxable. If the premiums are paid for by the employee, disability payments are received tax-free. Many companies use a salary deduction method in order to keep the payments tax free.

Business Overhead Insurance. Some insurance companies also have "business overhead" insurance, which activates upon the disability of the owner. Generally, all expenses, including wages and salaries, utilities, insurance and other operating expenses are paid by the insurance company to the insured company, which in turn, pays the vendors. Only the owner's income is not paid by this type of insurance; that is why individual and group disability income plans become even more important.

"De facto law." If the owner starts paying his or her salary, or other key people's salaries while they are out on disability, then by "de facto law" the business must do that for all employees in the same situation. While some business owners would not think twice about supporting a key person or themselves while incapacitated, they would have a more difficult time rationalizing paying an employee who comes in late and leaves early on a regular basis and does not help the "bottom line."

Resolution of Family Disputes

Problems in business planning usually occur when two or more children are actively involved in the business. Care must be taken while the head of the family business is still alive and working. Make sure that upon the business owner's death or disability, the chains of command are securely in place. All family members must understand their positions in order to keep the company operating efficiently and profitably. Family disputes among siblings can either wipe out years of goodwill with vendors and clients or put a final end to the business.

The problem of business succession is more obvious to outsiders than it is to the people running the family-owned business. If the owner has three children and only one child is involved on a daily basis with the business, does the child, who is active in the business, want his or her siblings to have an equal say on how the business is run? With three siblings now controlling the company, mistakes are liable to be made. Also, if the non-active siblings just want the profits and not the responsibility of running the business, why must the active sibling take on all of the responsibility and receive only a third of the benefits? Many family members do not want an active part in the family business, but they are not yet ready to walk away from the family business that helped to give them their current living standard. Also, in the minds of the business owners, they think everything will be "status quo" in their absence.

Improve Communications Between Generations

There are several areas of concern to consider in improving the lines of communications between generations. If the owner's spouse owns any part of the business, does the spouse have the same line of succession in his or her mind as the business owner? Also, if more than one child is involved, each might think that they are the natural choice to succeed their parent as the heir. These are items which, even though they may be uncomfortable to talk about, must be discussed and written into a business plan.

Control of the Company. Due to the possibility of sudden death or disability, it should be written in the business plan whether the owner's children, or another hand-picked successor, retain control of the company. If the stepparent gains control, does he or she keep the informal line of succession in force or does he or she now place their own "blood relatives" in charge? Even though the company's owner believes that his or her own "blood" children will be taking over the family business, if it is not written down in a company plan, then the new stepparent/owner can name anyone he or she wants to run the business.

Finally, how does the current spouse feel about either running the company or taking part in management of the company now or in the future? Having children or stepchildren active in the business may be a short-term solution unless succession planning is handled formally by an attorney, accountant and a life insurance agent or financial planner. It is best that the business owner's wishes, while alive and healthy, are those that will be carried out upon the business owner's untimely death or disability.

Smooth Succession Planning

Many business owners have lines of credit or bank loans to help their companies during lean times. What many business owners don't seem to realize is that upon their death or severe disability, the lending institution has a right to "call the note." At a time when a business needs that extra time to reorganize and reassure their vendors, clients and lending institutions that they plan on staying in business, the banks may inevitably force them to close their doors. Following are some examples of extreme situations that could occur when a business owner either dies or becomes disabled.

• Many accounts receivables may become impossible to collect. The business may also lose 70-80 percent of any pre-deaths value if sold to a specialized financial institution that purchases accounts receivable.
• Inventory, fixtures and equipment will be sold at an auction for a fraction of their value.
• Any goodwill is gone - a major loss for many small companies.
• Immediate push by creditors for full and immediate payment of all claims against the business. This may impair the credit records of surviving family members.
• The sale of all assets may satisfy creditors and the IRS, but leave nothing for the family.

Commitment to Future Success

It is important to have a formal business agreement in place that activates immediately upon death or disability of the primary owner. Then, the family-owned business will continue to operate under the stewardship of another family member or by a key person, if there is not a family member ready to step in. In this way, creditors, vendors and customers know that business will continue "status quo" which gives them the confidence to keep doing business with the family-owned firm.

Happier Work Environment

A formal business succession plan assures your employees, the main assets of the company, that their jobs are secure as well as the company. The sooner a business succession plan is relayed to the rank and file in the company, the smoother the transition will be. If there are more than two siblings actively involved in the business, they will know exactly what they are working for since everything has been spelled out to them in the business plan. In the case of no children, all key personnel will now know where their futures will be upon the death of the owner. For some, it is future ownership. For others, it is future management positions until the owner's children are ready to take over.

Why Continue the Business

When family members or key persons are suddenly in stewardship due to the death or disability of an owner, they could be put in a position of deciding whether it is in the best interest of all concerned to continue or liquidate the business. There are five main reasons to continue a business:

• It is not a good time to sell.
• The business is prosperous and provides the family members with an excellent income which exceeds what might be realized on the investment of sales proceeds.
• Profits are currently growing and are likely to continue to grow.
• A proven successor management team is available in the family or in the business.
• There is sufficient liquidity to meet cash needs upon the death of the owner.

Death and disability are not subjects that most business owners feel comfortable discussing. In order that their legacies survive to the next generation, however, plans must be formalized for these possible events. Astute business people will ensure that their businesses will not be sold in a depressed state or "fire sale" if any of the five reasons listed above occur.

Conclusion

A business succession team, consisting of the owner, attorney, CPA and life insurance agent or financial planner, should meet, as needed, to keep a business succession plan timely. Don't let procrastination and an untimely death or disability of the primary owner lead to a company's early demise. Proper planning can create a sort of immortality for the primary owner as the work and efforts of the owner can continue to grow after the owner is suddenly removed from the picture.

About the Author

Vic Butcher, CPA, LUTCF, is a sole practitioner in Cordova, Tenn. Butcher is a member of the Tennessee Society of Certified Public Accountants, the state professional organization for more than 8,000 CPAs in government, education, industry, business and public practice and its Memphis Chapter. TSCPA's Memphis Chapter is one of eight chapters across the state with more than 1,500 members in three counties. For more information on small business issues, visit the Tennessee Society of CPAs' Small Business Resource Center on the Web at www.tscpa.com.