Thinking Of The Future with Business Succession Plans

Last week we recognized the passing of Prince and discussed what impact the lack of a business succession plan might have upon his business empire. This week we’ll cover the elements of a business succession plan. First, it’s important to understand what a business succession plan is, and what it’s not. A succession plan is a way to transfer control and ownership of a business to predetermined key people over time in a way that does not harm current operations. It is generally comprised of a series of documents, including shareholder agreements, buyouts, stock pledge agreements, insurance policies and even your Will and trust documents. These documents all need to be coordinated to carry out your overall plan in a way that reduces confusion and removes the potential for lawsuits at what may be the most perilous time for your business. What you generally want to keep out of your plan are surprises. This isn’t the place to tell junior you’ve always disapproved of his moral compass because surprises lead to conflict, which often results in costly litigation. This is one of those times where Main Street can learn from Wall Street. Just like everyone wants to know Warren Buffett’s successor, your customers, partners, vendors and employees are happiest when everyone knows what to expect.

The core of any business succession plan is to spell out in writing how a change in control is going to impact the operation, and thus success, of your business. While there are lots of options, your choice will most likely be driven by your relationship to the person assuming control. For example, if the business is being left in the hands of a family member, or a trusted existing member of your business, you may want to consider having a stock buy-out that is funded by insurance or through a tax deferred account. This can be accomplished through a separate agreement or it may already even be in place if you have a well thought out shareholder or operating agreement. You can also structure the plan so the business assets can be leveraged for purchase financing, although this carries additional risk. Alternatively, if control is going to a new individual, or business for that matter, the insurance policy doesn’t work as well for obvious reasons. In those cases, we often see earn out agreements where retiring shareholders receive an up-front lump sum followed by a series of payments over time. Often these agreements require the departing owner to help transition clients to the new owner, gradually reducing their role in the company over time. For tax purposes, these deals may take the form of a “sweetheart” consulting agreement or just straight cash payments.

How these deals are structured, and financed depend on multiple factors unique to each business, but they all have some of the same considerations at the planning stage. Does it make sense to have your CPA do regular valuations of your business in case a shareholder wants to leave at some point in time? Should there be limitations on when a departing shareholder can cash out in order to protect the financial condition of the company? Are there key people who should be covered by non-compete agreements as part of any sale? These and other considerations are best discussed with your business attorney long before the succession plan actually needs to be used.

Switching gears to the non-legal considerations, it really should not be a surprise that not all of these reasons can be reduced to open communication. People do not like change. It places people out of their comfort zone, out of their normal routine and makes people unhappy and irritable. You should expect nothing different if you don’t both have a well thought out business succession plan and ensure it’s been communicated to all of the key players. If people know what will be expected of them going forward (increase or decrease in responsibilities), including salary, and it is communicated to them before it happens by the outgoing shareholder at an appropriate time, the odds of your business surviving the change of control increase. If expectations are not managed in advance you will frequently face resentment, which undermines morale and erodes the brand. Of course these non-legal considerations have significant legal impact and ultimately they too have to be documented. For example, perhaps a key shareholder will not agree to work under a new group dynamic? Then we are back to the primary legal concerns of some sort of buy-out and perhaps a non-compete that is structured appropriately in both geographic and temporal restrictions.

If you don’t take the time to at least think about these issues you may find yourself facing challenges at a time when you and your family are least prepared to deal with them. It’s a lot easier and cheaper to come to an amicable agreement that deals with these issues up front than it is to litigate them later. If you have any questions about business succession planning or shareholder litigation, please feel free to call us at Danziger Shapiro to discuss this or any issue affecting your business.

This entry is presented for informational purposes only and is not intended to constitute legal advice.