Episode 19 - Business Succession Planning
Episode 19 – Business Succession Planning focuses on one of the most important part of protecting an owner, member, partner, shareholder or investor in any company, and yet less than one in four businesses have a succession plan. In this insightful episode Jan establishes the purpose of a business plan: “how it is that you wish to transfer the operations of whatever you’re doing in the event of death or disability so that the company can continue and customers can be served, or you close the company and it ceases to exist.
In Episode 19 – Business Succession Planning Jan discusses the “reasons” business owners and stakeholders have for putting off this important process, while providing real life examples of what has happened to two example clients who failed to establish succession planning prior to the passing of the primary owner or key executive.
Jan
Welcome to AB Cast, integrating Legal Tax Accounting and Business Solutions. I am Janathan Allen. This podcast is about business succession planning.
Neil
Jan, I find it fascinating that most statistics show that only one in four businesses has a business succession plan in place. Maybe the first thing we should cover is, what is a business succession plan?
Jan
Well, a business succession plan is how is it that you transition the operations of whatever it is that you’re doing in the event of death or disability so that the company either goes on and customers are continued to be served, customers are clients, and or you close it down and it ceases to exist. And the issue is that most people don’t go through a business succession planning, or they don’t create a plan because it’s just damned hard.
Essentially, the succession plan defines what happens in the event of a potential divorce with a partner. It could be the death or disability of a partner or your death or disability. It could be extraneous or extraordinary circumstances. It could be a financial force or a catastrophe, it could be an earthquake. Whatever happens to disrupt the ordinary process of day-to-day business and its operations and what it is that’s in place to take care of all of the various contingencies that occur in the event of some sort of catastrophe.
Neil
So Jan, in its essence, what’s the ultimate goal of business succession planning?
Jan
The ultimate goal is the assurance of continued operations in a smooth and efficient manner so that it doesn’t impact employees, it doesn’t impact clients, and it doesn’t impact adversely the individuals that are left behind to, to take care of what whatever it is that’s happened.
Neil
And how about the value of the company itself?
Jan
Well, the value of the company is something that needs to be sustained, and that’s the reason you put a plan in place.
Neil
So why do you think it is Jan, that only one in four businesses have a succession plan?
Jan
Because it is the most complicated part of providing for essentially your business’ death or demise that one can think of. The only other area that we find such reticence is in trusts and estates.
Neil
Mm-hmm. <affirmative>
Jan
and getting individuals to complete a trust questionnaire because they don’t like to think about their own immortality. The same thing happens with a business. It’s sometimes easier just to let it go until there’s some catastrophic event and then all hell breaks loose. And the other comment that I generally get is I’m too busy, which leads to the point that you’re working too much in your business and not on your business.
Neil
Jan, selfishly, from a business owner’s point of view, why is it important to plan for business succession?
Jan
I think the answer to that question lies within the business owners themselves. And to the extent that an individual has spent their life building a business, the question is upon their death or disability, do they really want the business just to cease or has there been life work that should be continued because it continues to assist and help people further down the line? And I think to the extent that most business owners would say that what they’ve built is something that they would like to see continue, that’s the reason for the establishment of the business plan.
The business succession plan also does a couple of things. If you don’t have a business plan and something catastrophic occurs, the chaos that erupts because there isn’t the leader there to make the decisions, who’s going to do this? Who’s going to do that? Who’s going to make the ultimate decisions to keep the business going until whatever event has occurred can either be abated or ameliorated or moves on?
And to the extent that that chaos, and if you imagine if you have your own business and suddenly one day you weren’t able to go in, who in your office, who within your organization would be able to take over for you and say, this is what we’re going to do and this is how we will keep the business going. And so I think there’s an element of preservation for one’s life work.
There is the preservation of the life work because of the customers and the clients which that lifework serves. And then there’s the ultimate chaos that befalls family members in the event that there is no plan because someone will have to step into the void and make decisions for which they are not competently prepared.
Neil
And in a situation where there’s more than one owner, if you will, more than one stakeholder, this could also be something that happens in the event of one of their partner’s lives. Correct?
Jan
Absolutely. One of the first things that we do, and this goes back to the entity creation, is one of the elements that we build in to either the operational agreement or into the shareholders agreement or the bylaws of an entity is succession planning at the beginning. So that if you have partners, you have stakeholders that are in the organization or the business with you, that there is an element of planning at the beginning so that if something does happen, there is a plan in place, at least in the, the, the corporate governance documents that outlines what’s going to happen.
Neil
Jan, you mentioned that this business section planning should occur at the very beginning of the outset of the business. It can happen at any and any point along the way. What is the biggest risk to a business owner from the perspective of having other partners and events that might happen in their lives? Can you give us an example of that?
Jan
Well, sure. I think the most important part is business succession starts in the beginning. I think a lot of people don’t think about it when they’re setting up a company, whether it’s an LLC or a corporation. But the business planning starts when you create the entity, particularly if you’re taking on a partner. What happens if that partner dies? What happens if you die? It may not be death, it could be disability, it could be a divorce. It could be one of any number of things that goes back and impacts a stakeholder or shareholder or member’s ability to contribute to the organization. So in the beginning, when you’re creating the corporate or the LLC documents, you build into place what will happen in the event of the inability of a stakeholder or shareholder to continue.
That can be in the form of buyouts. You can buy out their share or interest. You can utilize insurance to ensure that the company or that the family is taken care of while the corporation or the entity has the funds with which to go back and find someone to fill the position that’s now being left because of death or disability.
But it happens at the very beginning. Those initial plans can help really solve the in initial impact of a catastrophe in the event of death or disability of a shareholder.
Neil
So let’s take a common example of divorce. So if your partner gets a divorce and their spouse gets half of their interest in your company, does that affect voting rights? Do you want to have another partner in the business that you may not even get along with? How does that work?
Jan
Well, again, that’s taken care of at the beginning when in the event that there’s a divorce, of course, you may not want your partner’s wife or your partner’s husband for that matter to come in and assist you with running the company. They may not have the capacity or the desire or the experience to do so. So those are things that are taken care of upfront. Those are taken care of in the corporate documentation, the creation of the corporation, the LLC, the operating agreement so that in the event of divorce, there will be a triggering mechanism that says, in the event that this happens, there may be a transmutation agreement that says the spouses of the shareholders or the members will not in endure to in the event of a divorce, so that you don’t face those types of issues. But in the event that there is the untimely divorce, and something happens, then there will be a buyout provision to ensure that you don’t have someone step into a business or have, have ownership within a business that really doesn’t have the intellectual or business acumen to do.
Neil
Jan, if we go back to that initial stat of one in four businesses have a business succession plan, that means 75% of the companies are up and running, they’re past the start. What do they do now?
Jan
Well, that’s the reason you put into place a business succession plan. The business succession plan is created to go back and identify those types of areas that need to be fixed and need to make accommodations for things that should occur or should have occurred in the beginning but haven’t. So you have the ability to amend a bylaw or you have the ability to amend an operating statement. You have the ability to go back and buy business insurance, keyman insurance. These are all things that can be identified, which is the reason the business succession plan is so critically important.
Neil
Jan, we’ve talked about the impact of business succession planning as it relates to the owner and partners that they might have stakeholders. What’s the impact on the business itself?
Jan
Well, the impact is critical. For example, if you take an owner of a company and you remove them from that company, who within that company is able, capable and has the experience to take your place? And I think in most instances, people will recognize that there really isn’t one person that could go back and step into those shoes. So the question for the business owner is, do you elevate those that are have been in the business or do you set aside funds? Do you create keyman insurance to pay for the search for individuals that can come in, be procured and step into a leadership role without coming through the ranks of the company itself?
Neil
Or thinking through a plan about how are we going to grow this from the talent that we have?
Jan
Exactly. And it’s an assessment that occurs through the planning phase of who is it that can and will be able to take the company forward in the event that the owner of the company is no longer able to do so.
Neil
So speaking of the owner, Jan, there are personal and family related issues associated with business succession planning for the owner of a business?
Jan
Absolutely. So when you initiate a business succession plan, oftentimes it will trigger an estate as well, because essentially what you want to do is you want to harmonize those two planning elements so that one fits hand in glove with the other. In the event that you become disabled, you want to ensure that you have the monetary means to continue on with whatever incapacity has been created. But by doing that, you have to ensure that the company has the ability to pay for what it is that needs to be done, whether it’s in the form of the sale of the ownership of the company, whether it’s in, uh, the form of insurance, long-term insurance, any number of financial vehicles can be utilized to go back and structure or accommodate that need. But for the family, it’s really critically important that their ability to continue on with their lives without a financial impact is a very critical component of this plan.
Neil
Jan, can you share a couple real life examples of maybe the existence of a business succession plan and how it saved the day or the lack of one and what happened?
Jan
Yeah, I can think of two competing scenarios. One was a client, a fairly small client that grew into a fairly large client and had three shareholders, and two of them were quite willing and quite able to develop an estate plan. The third partner really sort of dug in the heels and said, I’m not going to do this. The anticipation was from this particular partner was that if something were to happen to him, his expectation was that whatever he was receiving in compensation from the company would continue in order to keep his family going, even though there would be no one to step into his shoes.
So it created a very stressful succession planning process because you had two shareholders that were willing to accommodate the plan and one that just was going to put their head in the sands and say no. To the extent that we finally got through that process and that plan, we did get the plan accomplished.
But it’s fascinating to listen to people based on the expectations that they have that will happen in the event that something happens to them. It was unrealistic. It, it wasn’t achievable, it wasn’t financially viable, and yet that was the expectation for that partner. I think the other one is where there was not as good a result where the individual who had built a really substantial business and was doing really, really, really well, we had talked about doing a succession plan and, and of course I don’t have time.
The typical excuses that one hears over and over and over again because again, the succession plan has to go back in and review what the business is doing is doing and, and where are the pitfalls that need to be fixed in order to put the succession plan in place. And this particular individual found out that he had cancer. And what ended up happening in that particular instance was a very, very well-oiled machine suddenly stopped.
All of the employees were laid off, everything ground to a halt. There was nothing left. They came in and they shut the company down. There was no transitioning of either the employees or of the clients, and it was a catastrophic end. That could have been avoided, it could have been done in a much better fashion.
Neil
So what are some of the tax implication of a business succession plan strategy?
Jan
The tax implications are really a part of the process. A again, at the very beginning when one lines out how it is that a business succession will occur in the event of death, divorce, disability in the bylaws or the operating agreement or subsequent to the organization in the completion of a business succession planning, the ability to put together the plan in place as to how the business transfer or the effective ownership transfer will occur, whether it’s a sale, whether it’s insurance, whatever that financial means is gives you the opportunity to plan the impact of the taxes that will occur based on that transfer. To the extent that you leave it and you don’t plan for the effective transfer, whether it’s sale, whether it’s insurance, whatever formula that’s been created just leads to chaos. And so you may not know what even the, the potential financial opportunities are for the transfer, if there are any.
And if there are none, and suddenly you don’t have the wherewithal or someone doesn’t have the wherewithal to pay for the transfer of your ownership or pay you for the ownership for your transfer, that can lead you to a place of financial volatility that can be avoided through planning.
Neil
We’re talking about preserving and making sure the longevity of and the succession of all you’ve spent, your time and energy and money working to build, and for those that are around you and your family and those that are coming behind you.
Jan
That’s the whole purpose of planning. Planning is always the vehicle to go back and ameliorate the what ifs,
Neil
The what ifs,
Jan
The what ifs.
Neil
Jan. This is also an extensive integrated project. This isn’t just a legal project. This isn’t just a business strategy project. This is tax. It affects the legal structure of the company. How did the integrated services of Allen Barron affect a business succession plan?
Jan
Well, I think by now most everybody has heard me say over and over again that there really isn’t a business decision that can be accomplished in just one of those substantive areas. There really needs to be an integrated approach. Whether you do that with several firms by hiring law firms or accounting firms and tax firms, or whether you go with the approach that we have, which is the integrated approach, since we have all of those services in house, is really up to the owner. But it is the most critical component in terms of putting together a successful plan because you have to have all of those elements.
Neil
Thank you, Jan.
Jan
Learn more about our integrated legal tax, accounting, and business solutions and visit https://allenbarron.com or call (866) 631-3470 to schedule a free consultation.
Practices Areas
tax resources
legal resources
estate planning & trusts resources
accounting resources
business consulting & planning resources
Downloads
Contact Us To Learn More About Allen Barron's Services
For more information or to discuss your tax, legal and accounting needs contact Allen Barron or call 866-631-3470 for a free and confidential initial consultation. Learn about the importance of integrated business strategy and coordination across legal, tax and accounting systems.
Offices of Allen Barron, Inc.
Main Office
16745 West Bernardo Drive, Suite 260
San Diego, CA 92127
Phone: 858-304-0947
Phone: 866-631-3470
Fax: 858-376-1410
San Diego Office
5720 Oberlin Drive
San Diego, CA 92121
Phone: 866-631-3470
Fax: 760-741-1410
Las Vegas Office
333 South Sixth Street, Suite 230
Las Vegas, NV 89101
Phone: 702-749-4430
Fax: 702-933-1748
San Diego Office
750 B Street, Suite 2610
San Diego, CA 92101
Phone: 619-702-8356
Fax: 619-923-8356
San Francisco Office
300 Montgomery Street, Suite 410
San Francisco, CA 94101
Phone: 415-481-0475
Fax: 415-762-1539
Phoenix Office
40 North Central Avenue
Phoenix, AZ 85004
Phone: 602-903-7018
Fax: 602-357-1655