|Succession Planning for Business Owners|
|by Nichole Crawford, JD, LL.M, CLU, ChFC, CAP, Federated Insurance|
|Management Spring 2011|
By nature, business owners are entrepreneurs. They’re an optimistic breed – comfortable with risk, able to confidently figure things out and skilled at building something significant.
Historically, they have seen opportunities and seized the ones that made sense. These same traits can be applied to proper business succession planning as well.
Yet many business owners put succession planning on the back burner. A present-time focus on building and growing the business may be at the expense of the future. The problem with a lack of succession planning is that the future may be here all too soon. The legacy you eventually want to pass on to your loved ones in the “distant” future can be greatly impacted by the long-term provisions you make – or don’t make – now.
Business owners who don’t have a plan in place may be relying on “wishful thinking.” They may think, “My family knows what I want to happen after I’m gone,” or “Everyone will agree, so there’s no need for a formal, written plan.” In some cases, this couldn’t be further from the truth. What if there are children who are involved with the business and others who are not? Did the business owner intend for them to inherit the business equally, even though one or more may not have any intention of contributing to its operation? The answer will most likely vary, depending on which child you ask! Are the key employees on board with working for the business owner’s heirs, or will they move on to other opportunities after the business owner is gone? Will the banks holding notes from the company trust the new owners’ ability to make payments or will the notes be called? Will long-time customers be comfortable with the new ownership?
Many business owners want to pass their business to family members, but haven’t answered the question of “how.” The first step for business owners is to examine their ultimate goals. These may include
Estate planning documents, including wills and trusts, play an essential role in making sure a business owner’s intentions are carried out. A revocable living trust can avoid probate and hold assets for distribution to heirs until they reach a certain age. It also can help to protect assets from the heirs’ creditors or keep assets in the family in the event of a divorce.
Additionally, trusts are commonly utilized to help minimize estate and gift taxes. After a one-year repeal in 2010, the estate tax has returned in 2011. The amount an individual can pass to his or her heir without incurring estate taxes (the estate tax exemption) is currently $5 million per person ($10 million for a married couple), with a top rate of 35 percent for the estate, gift and generation-skipping transfer taxes. While it may seem that planning for minimizing taxation may be unnecessary with the high exemption amount and reduced tax rate, this is not necessarily the case. These amounts apply for the next two years (2011 and 2012) and are scheduled to return to 2001 levels (a $1 million exception and a 55-percent tax rate) in 2013. No one can predict what Congress will do in future years, but given the long-term fiscal realities of the federal government, it is probably safe to assume that there will continue to be some sort of estate tax in one form or another. The only estate tax law that matters is the one in effect when the business owner passes away, so the prudent course of action is to create a plan with some built-in flexibilities to adapt to future changes in the law.
No Formal Succession Plan
Even with a formal plan in place, another way a business succession plan can fail is when the owner doesn’t share the estate and business transfer plans with the people who will be affected the most – family, employees, franchisors, creditors and customers. Change can be stressful – even good change. How humans react to a “total surprise” change is unpredictable. With no discussion prior to a transfer event, there can be misunderstandings and unnecessary stresses, as well as lasting human and financial repercussions. Discussing future plans also can lead to conversations about how to put the future owners in the best position to succeed. For example, the current owner(s) may want to delegate some authority and “groom” the successors in the time leading up to the owner’s exit.
The buyer has several options for funding a buy-sell agreement. A savings or “sinking” fund could be established, but depending on the time frame involved, may not be sufficient to accumulate funds for a buy-out. An installment sale, through which the new owner pays the purchase price over time to the family or estate of the departing owner, may not provide the owner’s family with the income and security they need. Finally, life insurance can be a cost-effective way to provide the necessary funding to carry out a business owner’s wishes. Life insurance proceeds are available immediately upon a premature death of the insured, when the funds are needed most, and the death benefit received often can be obtained for pennies on the dollar. Depending on the circumstances of the buyer and the seller, a combination of these funding options may be appropriate.
No Expert Advice
Having a plan in place is the first step, but keeping the plan up to date is an ongoing process. Plans should be reviewed periodically to make sure they still reflect the business owners’ intentions and current laws.
Nichole Crawford is manager and counsel – advanced life sales for Federated Insurance.
This article is intended for general information purposes only and should not be construed as legal, tax or financial advice with respect to specific facts or circumstances. The contents of this article may be subject to regulations and restrictions in your state and are not provided as a substitute for any state standards that may apply. Neither Federated nor any of its employees provide legal, tax or financial advice. You should consult with your independent professional advisors regarding your specific estate planning needs. © 2011 Federated Mutual Insurance Company. All rights reserved.