Effective Succession Planning

by | March 13, 2012

Our guest blog post this week is from Ryan P. Scott. Ryan is a Financial Representative of Principal National Life Insurance Company and Principal Life Insurance Company.

Your business is not just your pride and joy but a major source of income for you, your family, and your employees. While the business is a large part of your life today, the reality is that someday you may want to retire, step back from the business to concentrate on new ventures or you could become disabled or unexpectedly pass away. What would happen to your business if you were no longer around to run it? Putting an effective succession plan into place allows you to take the guesswork out of transferring ownership, and provides peace of mind that your business, and your family, is taken care of.

If you’re like most business owners, you may plan to pass your business on to your family or sell it to co-owners. Ninety percent of the 21 million U.S. businesses are family owned. Yet only 30 percent of family-run companies today succeed into the second generation, and only 15 percent survive into the third (Source: SBA.gov). A major reason for this is the tax cost of passing on ownership.

Just as it was when you started your business, the key to successfully passing your business on is a well thought out plan. A well-designed succession plan can help meet your objectives and address management, control and funding of the business as well as coordinating with your personal estate plan.

What constitutes an effective succession plan depends on your particular objectives. Every plan begins with you deciding how you want to transfer your business. Based on those objectives, there are many strategies that can help you assure a smooth and complete transition of your business to new management and can control the tax burden for the new owners.

Some of the transfer options to consider are:

  • Family Limited Partnerships – These partnerships may be appropriate when parents want to maintain some control yet shift income and appreciation to their children. This arrangement may also help consolidate assets and reduce estate taxes.
  • Employee Stock Ownership Plans (ESOP) – ESOPs provide a method for owners to sell the business and possibly defer or even avoid capital gains taxation.
  • Irrevocable Trust – In cases where the family has not identified a buyer but wants to protect the continuity of the business, an irrevocable trust could be the answer. This trust holds and manages the business after the owner’s death until the time is right to sell it.
  • Buy-Sell Agreements – In businesses with multiple owners buy-sell agreements can be structured to facilitate smooth turnover of the business to the surviving partner(s).

Cross Purchase – In this agreement the surviving business owners purchase the deceased owner’s share of the business from the deceased owner’s estate based on the agreements established purchase price.

Entity Purchase – When an owner dies, the business buys the deceased owner’s interest. The surviving owners then own the entire business while the deceased owner’s estate is paid the agreed-upon price. This is also known as a stock redemption plan.

Begin building your plan by contacting your financial professionals – attorney, accountant, and insurance representative. They can guide you through the valuation process (vital in establishing the total worth of your business for tax purposes), recommend options that can help you achieve your objectives and provide vehicles for funding the plan. It will take all of your financial professionals working together to build a succession plan that will help accomplish your objectives, is flexible, properly funded and cost effective. Without a succession plan, the effect on your heirs, your estate and your business could be devastating.

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements. Byline: By Ryan P. Scott, CLU®, ChFC®. Financial Advisor, Principal National and Principal Life Financial Representative Ryan P. Scott, CLU®, ChFC®, Financial Advisor, is a Financial Representative of Principal National Life Insurance Company and Principal Life Insurance Company, Principal National (except in New York) and Principal Life are issuing insurance companies of the Principal Financial Group®, Des Moines, IA 50392. Pat can be reached at 515/123-4567.