BUSINESS SUCCESSION PLANNING — WHAT IS IT?
One of the important decisions a business owner must face is when and how to step out of the business — in other words, business succession planning or exit planning. Do you expect to retire from your business? Do you have a plan in place? What would happen to your business if you were to die today? Do you have children you hope to bring into the business? These are questions only you can answer, and your answers will lead you and your financial and legal advisors to a course of action.
When you develop a succession plan for your business you have two basic choices: you can sell your business, or you can give it away. Once you choose to either sell or gift, you can structure your plan to go into effect during your lifetime or at your death.
In this article, we will focus on options for selling your business rather than giving it away.
TRANSFERRING YOUR BUSINESS INTEREST WITH A BUY-SELL AGREEMENT
You can transfer your business interest with a buy-sell agreement, a legal contract that prearranges the sale of your business interest. It allows you to keep control of your interest until the occurrence of an event specified in the agreement, such as your death, disability, or retirement. A buy-sell agreement can help you solve the problems inherent in attempting to sell a closely held business. When you structure your agreement, you can tailor it to your needs.
WITH A BUY-SELL AGREEMENT, YOU CHOOSE THE EVENTS REQUIRING A SALE
When you draft your buy-sell agreement, you establish the triggering events, meaning those events under which the sale can or must happen. Common triggering events include death, disability, or retirement. Other events like divorce or bankruptcy can also be included as triggering events under a buy-sell agreement.
A BUY-SELL AGREEMENT PROVIDES A READY BUYER FOR YOUR INTEREST
At the occurrence of the triggering event, the buyer is obligated to buy your interest from you or your estate. The buyer can be a person, a group (such as co-owners), the business itself, or a combination. You (or your family or estate) are spared the task of trying to find a buyer when you are ready to sell.
PRICE AND SALE TERMS ARE PREARRANGED
A major function of the buy-sell agreement is the establishment of the pricing mechanism for the sale of the business interest. The payment method is typically also determined at the time the agreement is drafted. The major sale negotiation is conducted at a time when there is no pressure to sell. This eliminates the need for a fire sale when you retire, become ill, or die; and it may result in greater overall fairness in the deal.
A BUY-SELL AGREEMENT CAN INTERFERE WITH OTHER ESTATE PLANNING
Once you are bound under a buy-sell agreement, you can’t sell or give your business to anyone except the buyer named in the agreement without the buyer’s consent. This could restrict your ability to reduce the size of your estate through lifetime gifts of your business interest, unless you carefully consider and coordinate your estate planning goals with the terms of your buy-sell agreement.
SELL YOUR BUSINESS INTEREST
The major benefits when you sell your business interest are control and cash: you keep control of your interest or business assets until you are ready to let go, and you decide how much or how little you want to sell.
SELLING ALLOWS YOU TO RECEIVE CASH (OR CONVERTIBLE ASSETS) AND CHOOSE THE TIMING
When you sell your business interest or assets, you receive cash (or assets you can convert to cash) that can be used to maintain your lifestyle or pay your estate expenses. You can choose when you want to sell — now, at your retirement, at your death, or at some point in-between. You can sell your interest during your lifetime, and receive cash to use for your retirement, a new business venture, or that trip around the world you’ve been putting off. When done at your death, an asset sale can provide cash for your estate to use in paying your final expenses or for distribution to your beneficiaries.
A LIMITED MARKET MEANS A SALE COULD BE DIFFICULT
There is often no market for the sale of a closely held business, which could make finding a buyer for your interest difficult. Some assets, such as equipment, may have a specialized use or a short time frame of technological usefulness. If your business is a service business, it may be hard to find a buyer for intangible assets such as your customer list. The level of competition in your geographic area or business field could also affect your ability to find a buyer. When the sale occurs after your death, your family or estate may be at a distinct disadvantage when negotiating with a potential buyer. The interested buyer can be expected to try to take advantage of your family’s need for cash to settle your estate expenses and offer a price that is below a fair market value. A buy-sell agreement might be the solution to prevent this from happening, because it guarantees a buyer for your interest.
SIZE OF BUSINESS INTEREST, ESTATE COULD MAKE SALE DIFFICULT
The larger the size of your business interest, the more difficult it may be to find a buyer with access to sufficient cash or credit on short notice. In addition, the larger the size of your business relative to your entire estate, the greater the need for cash to settle your estate expenses. Again, transferring your business interest with a buy-sell agreement might help you to solve these potential problems. Smaller business interests are not without their own problems. Buyers may be reluctant to purchase a minority interest because such an interest doesn’t carry with it the ability to control the business.
Next quarter, we will discuss options related to gifting your business, which can occur during your lifetime or upon your passing.
CHOOSING THE RIGHT TYPE OF SUCCESSION PLAN
Depending upon your particular situation, one or more of these tools may enable you to achieve the specific goals you have established regarding the sale of your business. Our Merger & Acquisition Advisors at BWFA can help navigate the various succession strategies available to you.
Brian Macmillan | Managing Director | Mergers & Acquisitions | bmacmillan@bwfa.com