How to Build a Succession Plan
Does your business have a succession plan in place? A succession plan is an important element to keep your business profitable if there is a change in ownership due to death, disability, retirement or another “Event” that affects one or more Exiting Owners.
Following an Event, the ownership of a business usually passes to (a) a member of the Exiting Owner’s family, (b) the other owner(s), or one or more employees. The intention should be clearly outlined in the Shareholders’ Agreement (for a corporation), an Operating Agreement (for an LLC), or a Partnership Agreement (for a partnership).
The optimal time to create a succession plan is when the business entity is formed. Making important decisions about the continuity of the business early on can save legal fees, time in court, disagreements and distraction later. However, if you failed to make a succession plan when you set up your business, it’s never too late.
Our first step in creating a succession plan is to help our clients complete a detailed questionnaire. The questionnaire forces them to consider and prepare for many situations that may occur should an Event trigger the sale of shares or transfer of ownership. We address such topics as:
1) HOW THE COMPANY’S VALUE WILL BE DETERMINED.
What method will be used? Will it be done in-house or by an independent accountant?
2) THE OBLIGATIONS OF THE OTHER OWNERS/BUSINESS IF AN EXITING OWNER BECOMES DISABLED.
Will the Exiting Owner’s activity in the business be considered? What would be the definition of “permanently disabled” and who would make that determination? At what point would the disabled Exiting Owner’s sale of his/her ownership interest be activated?
3) THE STRUCTURE OF BUY/SELL ARRANGEMENTS.
Will the purchase and sale be structured as a so-called “cross-purchase”, whereby the remaining owners to have the first option to purchase the ownership interest from the Exiting Owner? Or a redemption that grants that option to the business?
4) OWNER TERMINATION STIPULATIONS.
If an Exiting Owner terminates employment or is terminated, does he/she have to sell his/her shares? To whom? Under what conditions and terms?
5) LIFE INSURANCE NEEDS.
Will there be life insurance on the lives of owners that could be used to fund or partially-fund the transfer of ownership? Will it cover all out-of-pocket costs to be paid out in case of an Event?
6) BENEFICIARY RIGHTS.
In a family business, must the deceased Exiting Owner’s ownership interest be sold or can the beneficiaries retain and receive such ownership interest as part of the distribution of the estate? Are the Exiting Owner’s heirs to receive immediate payment or can the purchaser(s) pay over time?
7) SALE TO OUTSIDE THIRD PARTIES.
Can an owner sell/transfer his/her shares to an outside third party? Will the first option be given to the remaining owners or the business before ownership can be sold or transferred to an outside third party?
8) NON-COMPETE CLAUSES.
If an owner disassociates from the business, either voluntarily or involuntarily, will that Exiting Owner be precluded from “competing” with the business?
How will competition be defined? How long will the restriction last? In what geographic area? Do trade secrets need to be protected?
These are just some of the questions we discuss when we build a succession plan for your business, whether you are operating as an LLC, a partnership or a corporation. When it comes to planning, it’s never too early or late to create a succession plan for your business. At Gardi, Haught, Fischer & Bhosale LTD, we have helped hundreds of businesses build insightful succession plans to simplify the ownership transfer process. If you need help building one for your business, please contact Keith Zerman today at 847-944-9400.