You've worked long and hard to build your business, possibly decades. You have loyal clients, bright employees, a quality product or service - and you're making money. But have you considered what might become of your hard work and success when you retire, or worse, if you unexpectedly become disabled or die?
According to a 2010 survey by Korn/Ferry International, only 35 percent of executives said their company had a succession plan. Failure to properly plan for the future can derail your retirement goals. “Worse yet,” says Barton B. Burns, Comerica's vice president of Wealth Planning, “Businesses caught unprepared by the owner's sudden disability or death may risk floundering and possible loss of value, as well as loss of negotiating leverage for a potential sale as key executives may jump ship.” If you have a succession plan for your business, great; if not, it's vital to start working on one today.
Many owners prefer to transfer the business to their children, especially if it's a longstanding family venture. But don't let sentimentality or family pride blind you to reality. Are your offspring really interested and capable of running the business? You may also want to ensure that all family members are treated fairly from an inheritance standpoint, and that the transition is handled so as not to alienate key managers or employees who may feel resentful toward the heir(s).
Alternatively, if an owner wishes to sell his firm in the future, Burns recommends having a funded “buy-sell agreement” in place with potential successors that takes effect upon a triggering event such as death or disability of the owner.
“The agreement may be funded with a life insurance product that names the purchaser - a family member, business partner, or key employees - as beneficiary. The policy proceeds are used to purchase the business from the owner's estate,” says Burns. Buy-sell agreements should provide a clearly defined method for valuing the business at the time of transition to ensure that the owner, their family, or their estate receives a fair price at a time when they may have little leverage for negotiation.
Another option is to simply sell your business to an outside third party. This usually requires the assistance of a business advisory firm that can help determine a realistic value for the company, identify potential buyers, and help the owner negotiate favorable terms for a sale. In certain professional practices - medical, legal, and accounting - the owner may be able to approach competitors directly to discuss a potential sale. Of course, any sale will involve tax issues, and business owners must be aware of the various strategies available - for example, a stock sale vs. an asset sale - to offset or minimize those taxes.
Some business owners want to sell their companies to key employees. But if those employees don't have the ability to buy the company, the owner may have to finance the sale. This action can be risky, however, if the new owners can't generate enough income to pay the loan. This risk can be mitigated by including provisions in the sale such as mandatory financial reporting, solid collateral agreements, obtaining personal guarantees, and even taking liens on the buyers' personal assets.
Another option is for employees to have an ownership stake in the company, where a vested interest in the organization will help to ensure they will act in its best interest. If you operate a C or S corporation, an employee stock ownership plan (ESOP) enables employees to buy the owner's shares for deposit in their retirement plan. “It's a way to create a market for otherwise illiquid shares, allowing you to slowly divest ownership and move toward a more diversified portfolio,” says Burns. “It's also a hedge against the buyer cleaning house and replacing your staff with his own people since your employees have a stake in the company.”
An effective business succession strategy must accommodate an orderly “changing of the guard,” whether at retirement or after an unexpected disability or death, but planning should begin early. “Having a well-defined plan in place can help the business owner reach their goals for retirement and ensure their loved ones will be treated fairly,” says Burns.
Comerica’s Wealth Management team, in conjunction with your Business Banker, can work with you and your other advisors to create an integrated business succession plan. For more information, contact your Comerica representative.
Note: Transitioning a company to children as a gift is especially attractive this year because the Federal estate and gift tax exemption is $5,120,000. This exemption is scheduled to drop to just $1,000,000 in 2013 when the estate tax rate will rise to 55 percent from 35 percent today.
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