Business Succession Planning

Business succession planning: where business law and estate planning intersect. A main concern of the owner(s) of a closely held business is what happens when the owner(s) die, retire or become disabled. Generally, one of three things happen: the business continues, the business can be liquidated, or the business can be sold to new owners. With proper succession planning, business owners can plan for the business, just as they would with their estate. For example, if a child of the business owner also works in the business, the owner may wish to leave the business to that child.

Business owners have two main considerations: their estate plan and any tax consequences their business may have upon their estate, and second, the continuity of the business itself. The estate plan steps in to reduce, as much as possible, the taxable consequences to their estate upon the business owner’s death. Depending on the value of the business, its assets and the owner’s estate, tax deferral mechanisms such as portability or the marital deduction can be used to reduce or postpone the taxable liability.

Business owner’s, though, have another concern. What happens to the business itself? If the business has only one owner, the options are more narrowed. The owner’s estate may sell the business after the owner’s death, or the business may be liquidated. But, when the business has more than one owner, a buy-sell agreement is critical. A buy-sell agreement spells out when an owner’s interest is to be sold, and what the agreement is for that interest to be purchased.

A buy-sell agreement spells out events that trigger the sale of the owner’s interest. Death is one such event, but other events are usually included such as disability and retirement. Upon this triggering event, the interest of the deceased owner is sold, at a value specified in the agreement, to a party or parties also specified in the agreement. The buy-sell thus works to attach a value to the interest in the business, and spells out to whom that interest is to be sold. Usually, the other business owners will purchase the interest, or the business itself will purchase the interest. The remaining owners want to ensure that the closely-held structure of the business remains intact, and there is not an unknown third party that becomes part of the business after the death of one owner.

Business owners typically either take out life insurance, or the business itself takes out life insurance on the owner, to provide some funds to purchase their interest upon death. This type of insurance is typically called key man insurance, and this is part of the succession planning process. The proceeds from the insurance policy work to protect the purchaser and provide some funds to buy out their interest.

To discuss business succession planning, please contact Benjamin Long of Schmidt & Long.