For many business owners, their company makes up a large part of their identity. Building a company from the ground up is a unique personal success that proud owners may want to pass on to their loved ones. It can be difficult for an owner to discuss succession, but at some point, they will have to decide to sell the business or pass it on to someone they trust.
Having a succession plan is a good idea for two reasons: (1) It will give the owner a smooth transition out of the business and (2) it can reduce headaches and stress in the event of an owner’s sudden departure, such as illness or death.
A succession plan makes it clear who will take over the business, reducing any inherent disputes between parties. A well thought out plan aims to benefit everybody — the departing owner, their family, the business and the successor.
Today’s blog features the five common ways to transfer ownership of your business, as well as the pros and cons of each exit option in detail.
1. Sell Your Business to a Co-Owner
If you found your business with a partner, you might consider your co-owner as a potential successor. Many partnerships formulate a mutual agreement that explains what will happen in the event of one owner’s untimely death or disability. The remaining owner(s) will agree to purchase their business interest from the deceased owner’s next lineage. This agreement can make an unexpected transition easier for both the business and family members.
Let’s say that a spouse wants to keep his or her shares, but doesn’t have time to invest entirely in the business. A buy-sell agreement guarantees that they’re given fair compensation, and allows the remaining co-owner(s) to maintain control of the business.
One downside to a buy-sell agreement with a co-owner is that it requires a lot of cash to be kept on-hand. Your co-owner must be prepared to buy out your shares at any moment.
An alternative is to fund a plan with life insurance. Both term life and permanent life insurance can yield a profit if an owner passes away or retires. At Davidson Law Group, we can help you determine the type of insurance policy you’ll need.
Related Post: Beginner’s Guide to Business Planning
2. Pass Your Business On to an Heir
If you have children or family members working in your organization, it’s common to pass the torch on to an heir. Again, this transition presents some pros and cons. On the positive side, you’d benefit your family by providing them a fully-functioning operation. On the other hand, like any major family decision, it could get messy if not planned accordingly.
If you have multiple children, nieces, and nephews who want to take over the business, it can become complicated. We recommend that you provide clear instructions for who will take over what and explain how the others will be reimbursed.
Typically, you should not grant ownership to family members who aren’t involved in the business. It’s smart to include a buy-sell agreement in this situation. Your heirs who are not active in the company would agree to sell their shares to those who are.
As for your family who stays in the business, you should pick a single successor rather than splitting ownership evenly between your heirs. Businesses are generally more difficult to manage with multiple decision-makers.
3. Sell Your Business to an Employee
When you don’t have a co-owner or family member to take over your business, you might consider selling it to a key employee instead. Selecting someone who is experienced and respected by your staff can make the transition much easier. This way, you have the ability to train them and get them on board with essential procedures.
A key employee succession plan also requires a buy-sell agreement. Your employee will agree to purchase your business at a prearranged retirement date, or in the event of death or disability that means you are incapable of managing the business.
One disadvantage of employee succession is money. Most employees aren’t able to buy the business they work for; and even if they are, they probably don’t have enough cash on hand. However, there is a solution. Seller financing allows your employee to pay you (or your family) back over time. The exact terms of a loan will need to be negotiated, then distinctly laid out in your succession plan.
4. Sell Your Business to an Outside Party
When no obvious successor exists, business owners may search for another entrepreneur — or even a competitor — that would purchase their business. The difficulty of this decision depends on what type of business you own. For example, it could be more challenging to sell a real estate company that’s branded under your own name, as opposed to selling a restaurant with an experienced general manager. The need to rebrand and restaff may impact prospective purchase prices.
Hiring and training a dependable general manager is a good way to prepare your business for sale. Also, gather all of your financial documents, such as tax returns, inventory, and up-to-date records. You will want to make your business as stable as possible, so it’s more attractive and valuable to outside buyers.
Related Post: Business Succession Planning with Davidson Law Group
5. Sell Your Shares Back to the Company
An “entity purchase plan” or a “stock redemption plan” is an arrangement where the business purchases life insurance on each of the co-owners. When one owner dies, the business uses the life insurance earnings to purchase the business interest, which gives each living owner a bigger share of the business.
The difficult aspect here is ironing out all the details. An entity purchase is similar to a cross-purchase, where you sell your shares to a co-owner or co-owners. But here the business itself will purchase the ownership interests.
In most circumstances, a cross-purchase is more financially viable. When your co-owners purchase your shares directly, they get a readjustment of the value at its current price. With an entity purchase, the original basis remains, and your co-owners will be responsible for potentially higher capital gains.
Despite this drawback, entity purchases can still be beneficial when you have a large number of co-owners. Drafting cross-purchase agreements with each owner can be inconvenient. An entity purchase agreement, though, is much simpler to implement. It can typically be funded with a single life insurance policy for each co-owner.
Business Succession Planning With Davidson Law Group
Whether you are a small or large business owner, the legal and emotional hurdles of passing on your business can seem overwhelming. Our experienced Business Law attorneys will help you build a realistic and achievable plan, and guide you through each step of the process. We will ensure that your business is set up for success after your retirement. For more information on how we can help, contact our office in Fort Worth, Allen, or Tyler today.