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Profitable Succession Planning

Author: James A. Andersen, CPA
January, 2011 Issue

Planning for the future should be part of every business' operational strategy.

A pressing need for all private business owners today is to develop a plan to exit their business in an effective and profitable manner. Whether the goal is to sell for maximum profit, transition the company to key employees, or minimize estate and wealth transfer costs by gifting the business to various family members, a business plan needs to be developed that addresses all of the possibilities.

A successful business succession/exit plan addresses all of the issues that can maximize value in a sales transaction, ensure a smooth transition in an employee transfer situation and provide the necessary stop gaps for transfer tax minimization of a family business.

The business succession and exit planning process requires a team of professionals quarterbacked by a CPA/financial adviser. Other critical team members include attorneys (probably multiple for dealing with buy/sell and estate issues); an experienced insurance professional with expertise in life, health and disability issues; and either a banking or investment advisory firm with expertise in wealth management and family trust issues.

Failure to create a well-defined business succession/exit plan virtually
guarantees business owners can:

•    Exit their companies as a result of pressure from outside circumstances, not as a result of their own desires;
•    Exit their companies on a timetable that’s forced on them instead of one that meets their needs;
•    Undervalue their companies and leave hard-earned wealth on the table;
•    Pay too much in taxes (income taxes on a business sale and wealth transfer taxes in family-owned business situations);
•    Lose control over the process by being reactive and therefore limit exit options;
•    Fail to realize all their business and personal goals;
•    Suffer unnecessary psychological stress; and
•    Watch a lifetime of work disintegrate as a result of poor business continuity planning.
On the flip side, a well-designed and implemented exit plan lets business owners:
•    Control how and when they exit;
•    Maximize company value in good times and bad;
•    Minimize—and possibly eliminate—income and wealth transfer taxes;
•    Generate a number of strategic exit options;
•    Reduce stress
•    Ensure continuity of the business.
Multiple surveys have shown that the number one reason small, closely held businesses fail—or only partially succeed—is lack of planning. The scary thing is, most business owners spend more time planning a family vacation than when and how to exit their business.

Just as most of us don’t want to talk about our own deaths, business owners don’t want to talk about the end of their business. Plus, exit planning is a time-consuming and complex process, and very few resources exist to guide a business owner through it. Most owners are swamped with day-to-day activities and don’t understand the tremendous return on investment exit planning can provide. As a result, they favor the status quo and do nothing.

The combination of an intense need for exit planning and an equally intense resistance to create such a plan can cause powerful tension in a business owner’s mind. The important thing to remember is, whenever change is imminent and unavoidable, the adviser who can help clients make that change smoothly and painlessly becomes invaluable.

So how do you get started? The process must begin with two pieces of information: the business’ value and the owner’s motivation. The three most common business transfer motivations are:
•    To sell the business at the highest possible value and receive the maximum return on investment;
•    To transfer the operation to key employees while possibly trying to stay with the business in a reduced capacity to help facilitate the transition process; and
•    To keep the business in the family by transferring it at the lowest possible price to help minimize income and wealth transfer costs.
The first step in selling the business would be to get it valued. What happens if it’s determined the business doesn’t possess significant value? The financial advisers then need to perform a SWOT analysis (strengths, weaknesses, opportunities and threats) and encourage the business owner to make the changes necessary to maximize value.

The next step is deal structure: Should this be an asset sale or a stock sale? Should an installment sale be considered to spread the tax consequences over an extended period of time? What are the additional risks of an installment sale?

Transferring the business to key employees raises a whole separate set of issues. If it’s a professional service business, such as a CPA firm, the plan must include a structured buy-in that will “incentivise” new partners coming in but also provide a means for retirement for older partners. What’s a reasonable way to buy-out retiring partners while not burying the remaining partners with debt that’s difficult to service?

And an operating business, such as a manufacturing company needs to decide if a SARS (stock appreciation rights) plan or an ESOP (employee stock ownership plan) makes sense. Should it consider recapitalizing the business by issuing more stock and then redeeming the founding shareholders’ equity?  

Finally, if the goal is to transfer the business to family members at the lowest possible income and wealth transfer cost, the business value should be as low as possible. Beyond that, how does gifting work?  What about sales of minority shares on an installment basis? How do minority and marketability discounts come into play in either a gifting or minority sale situation?

Ineffective or nonexistent business succession planning can potentially mean the death of a significant family asset. Proper planning is essential to not only preserve the business entity but also avoid discord and misunderstanding among family members. Getting together with your financial and legal advisers to plan and draft an appropriate exit strategy is a good starting point.
James A. Andersen CPA, ABV, ASA is a partner in Burr Piler Mayer LLP in Santa Rosa.  You can contact him at


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