Business Succession Planning & Transfers Research Paper Starter

Business Succession Planning & Transfers

(Research Starters)

The succession of a closely held family owned business to the next generation presents a complex challenge. Historically, family owned businesses have not fared well through the generations; a fact that underscores the need for careful and comprehensive business succession planning. To maximize the effectiveness of a succession plan, attention should be given to both the financial and nonfinancial aspects. Financial aspects include considerations of tax, finance and law. The nonfinancial aspects are concerned with the relationships, expectations and desires of the family members. This article gives an overview of some major points in the area of business succession planning.

Keywords Business succession plan; Buy-sell agreement; Estate planning; Family owned business; Business Transfers

Business Law: Business Succession Planning


Family owned businesses are important to the United States' economy as well as the growth of the nation, as measured by gross national product (GNP) to family owned business. They are also significant creators of new jobs, generating an estimated nine out of every ten new jobs (White, Krinke & Geller, 2004). The entrepreneurs that own and operate these businesses are often fully engaged in the day to day operations of their enterprises. They must increase revenue, limit costs, secure adequate staff, and meet financial obligations; these activities leave little time to consider the future of their businesses. Only about one third of the businesses survive until the second generation and only ten to twenty percent make it until the third generation. This difficulty can be largely attributed to the lack of trained and capable successors to run a business. That problem can largely be overcome by a clear and well designed business succession plan (White, Krinke & Geller, 2004).

Business succession planning is the process of creating and implementing a strategy to turn over control and ownership of a family business as a going concern. It is the owner's exit strategy that seeks to achieve the owner's financial and family objectives. Ownership of a business typically represents a substantial portion of the owner's overall estate and warrants careful consideration. Unlike other parts of a person's estate, which can be handled with the familiar estate planning tools including wills and trusts, a business succession plan presents a separate challenge that typically involves more complex issues, related to the difficulty of maintaining successful operations.

The business succession plan, as part of an individual estate plan, is the topic of this article. Accordingly, the primary object of a business succession plan is the closely held family business. A closely held business refers to a business, usually a corporation, whose stock is not freely traded and held by a few shareholders. The succession of the business can be to either family members or non family members, depending on the owner's goals and particular family situation. Either way, the process involves complex legal, tax, financial and management planning issues that can extend over a lengthy period of time. The planning process must also involve many people, including; family members, professional advisors, shareholders, partners, and key employees. To ensure the maximum result, it is preferable to begin succession planning earlier rather than later. An unexpected death of a business owner can cause extreme emotional and financial problems for a family. And without proper planning, the sudden lack of leadership and management can cause a business to suffer and ultimately contribute to the failure of the business. Moreover, unmitigated tax consequences of an unexpected death can be disastrous and can cripple the financial condition of the business and the family member who inherits it.

Separating Ownership from Control

A common initial step before a specific technique is employed to transfer the ownership of a business is to separate the ownership from control. Typically, in a closely held business, stock or units (in the case of an LLC) have voting rights and therefore ownership of a majority of the stock results in control of the business. Ownership and control are unified. Ownership and control can be separated by recapitalizing the company into voting and non-voting shares. Recapitalizing means to alter the way in which the financial interests of a company are held. For a simple example, a company with one class of shares would be said to recapitalize if an additional class of non-voting stock were created in addition to voting stock. As a general matter, a corporate structure vests the authority to manage a company in a board of directors and the board of directors appoints officers to manage the daily operations of a company. The shareholders, by voting their shares, elect the board of directors. By use of votes, the shareholders in the corporate structure ultimately control the company, despite being a couple steps removed. In the case of a closely held family corporation, a single person or a few people tend to have multiple roles and the loss of control can manifest more quickly and directly than in a large publically held corporation. An owner may be the chair of the board of directors, the president and a significant stockholder. With a single class of voting stock, transfer of the stock would also cause the loss of control by the owner. By separating the stock into voting and non-voting stock, the owner can retain control over operations during life and begin to transfer ownership of the company to others in the form of nonvoting shares.

Alternatively, a family limited partnership could be set up with control settled in the general partnership interest and only ownership settled in the limited partner interests. This method is the same concept as in the case of a corporation. As a general matter, a limited partnership is a partnership between a general partner and any number of limited partners. Similar to the owner of voting shares in a corporation, the general partner has control over operations, and like nonvoting shares in the corporation, the limited partners have only a financial interest in the business. The limited partners have limited legal liability and limited involvement in the business. The general partner has unlimited liability and ultimate control and responsibility for the management of the business. Under either method, after the restructuring, the primary owners will have both controlling and non-controlling interests in the business and can begin to transfer the business by giving away the non-controlling interests to family members (White, Krinke, & Geller, 2004).

Transferring Interest to Family Members

There are several options for a business owner who wishes to transfer an interest in a business to family members. As a general matter, there are four ways to transfer ownership, by gift during life, by gift at death, by sale during life and by sale at death. Gifts of stock during life can be made tax free to the extent provided by the IRS ($12,000 per year per recipient at the time of writing). Each gift reduces the size of the owner's estate and reduces the potential for estate tax liability at death. However, to qualify for tax free treatment, the gifts must be complete and the owner loses control of the stock once gifted. Gifting is a method that can be effectively employed over time and is a relatively simple transaction. However, a critical part of the choice for a vehicle to transfer a business is tax planning and tax planning is a highly specialized field of endeavor. Tax professionals including accountants and lawyers may use several particular measures according to current state of the appropriate tax law. The important point to remember is that tax considerations are very important to the process and should be considered carefully by a competent professional.

Buy-Sell Agreements

The buy-sell agreement is a very important succession planning tool that transfers ownership to another generation and may often be combined with gifting to accomplish the desired transfer. A...

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