Challenges in Business Succession Planning
A lot of issues can arise when a small business attempts to transfer ownership(in a process known as business succession); these obstacles are universal in that they can affect transfers in any and every industry. In a majority of cases, family businesses go through failed successions due to three primary pain points—people, taxes, and cash.
CHALLENGE 1: THE PEOPLE
Whether the circumstances around the succession involve the death, retirement, or disability of the owner, the next in line for the ownership to be transferred can be a topic of hot debate. This is even more exacerbated in a situation where family is involved in the business. Determining who will take on the business is a difficult decision to make, and it must be made with careful planning and consideration for all parties involved that may have a stake in the business; the spouse, sibling, son or daughter, a vital employee, et cetera.
CHALLENGE 2: THE TAXES
Federal and state taxes imposed on the estate must be considered when planning business succession. These taxes are subject to regular changes year by year, so one must be careful in observing the climate of the matter. If a person does not consider and plan accordingly in regard to state and federal estate taxes, they may have to resort to selling the business in order to make ends meet on an estate tax.
CHALLENGE 3: THE CASH
Without substantial coordination on the financial aspects of succession planning, you may not have enough funds to complete certain succession objectives. Once you are sure you are sufficiently funded for the process, you will ensure that liquidity is able to be distributed to any related taxes or debts that have been incurred. If applicable, life insurance can be utilized to fund those objectives in the business succession process.
WHAT IS THE BUY-SELL AGREEMENT FOR BUSINESSES?
A Buy-Sell Agreement, abbreviated as BSA, is the most pertinent document you would need in order to transfer a business from one owner to another. When an event occurs that is specified in the contract (disability, death, retirement, et cetera), then the transfer of ownership is initiated. Several business entity types are covered under this agreement, including partnerships, limited liabilities, and corporations. A BSA can also apply to businesses that already have more than one owner! One indispensable feature of the BSA as a contract is its obligation towards third parties related to either the owner or the estate—this makes certain that full control and ownership is relayed to the appropriate person in a trouble-free process. And last but not least, value can be instituted for the business for estate tax purposes on the federal level, bound by the IRS under Internal Revenue Code § 2703.
THE THREE COMMON FORMATS OF A BUY-SELL AGREEMENT
The BSA contract can be drafted in several different formats depending on the intention of the purchase; in general, a Buy-Sell Agreement can be prepared in 3 main ways.
- An Entity BSA refers to the business entity buying the departing business owner’s interest/shares. This type is suitable for a business that helps a large group of owners.
- A Cross-Purchase BSA entails that the remaining business owners buy the departing business owner’s interest at a particular price once the “specified event” in the contract has occurred. This type is suitable for a business that helps a smaller group of owners.
- A Wait-And-See BSA is often seen as a combination of both the Entity and Cross-Purchase BSA. As a general rule, the business entity is given the priority option to buy the departed business owner’s interest before the other owners are able to purchase.
- Note that if the purchaser is an unrelated third party (and there is only one business owner that is selling), a One-Way BSA can be utilized.
There is a plethora of criteria to evaluate when selecting the best-fitting Buy-Sell Agreement, for both tax and non-tax reasons. However, we advise that extensive information regarding this topic should be discussed with either a tax advisor or an attorney.
HOW CAN I FUND A BUY-SELL AGREEMENT?
Of the several ways one can fund a BSA, some frequently used alternatives include insurance, personal finances, borrowing funds, a sinking fund created in the business, installment payments, et cetera. When utilizing insurance as an option to fund a Buy-Sell Agreement, keep in mind that it can deliver full financing of the purchase. If drafted appropriately, a BSA will incorporate life insurance as well as disability buy-out insurance. Ensure that you obtain the right coverage as soon as possible so that your insurability isn’t hindered by any health conditions you may develop at a later age. Make certain that your business’ survival is not left up to chance or mishaps, and get a consultation about the best BSA for you, today!
THINGS TO REMEMBER IN FAMILY BUSINESS SUCCESSION PLANNING:
- The majority of challenges in succession planning lie in the people involved in the succession process, the lack of preparation in facing state and federal estate taxes, and the insufficient budgeting of funds in order to complete the business succession.
- In order to legally transfer ownership of a business, a Buy-Sell Agreement must be drafted up and established. There are several formats it can be outlined in, including an Entity BSA, a Cross-Purchase BSA, and a Wait-And-See BSA.
- There are multiple ways to fund a BSA, but insurance is typically the best-case scenario.