What is Business Succession Planning?

Business succession planning is the legal framework for preparing for the transfer of ownership and management of a company to the next generation, which may include family members, key employees, or third-party buyers. 

A succession plan should include three key components:

  • Appointing successors
  • Establishing valuation of the company
  • Determining the timeline for transition

Why Should Business Succession be Included in an Estate Plan?

A business is likely one of the highest assets owned by a grantor and should be heavily involved in the estate planning process. Integration into an estate plan allows for the following:

  • Protection of business assets and ensures continuity
  • Minimization of tax implications and other financial burdens on the estate
  • Provides for financial security 

What are Key Components to Consider for a Succession Plan?

Asset protection and succession planning are important for all business owners to consider. Key components of a succession plan should involve the following:

  • Buy-sell agreements: These agreements are legally binding contracts between a business owner and their partners or shareholders that establish a predetermined price and terms for transferring ownership interests in the business. These terms are typically triggered by specific events, such as the owner’s death, disability, or retirement. An established buy-sell agreement protects the family and surviving business partners from disputes and future uncertainty for the business. 
  • Succession plans: A succession plan identifies and grooms a successor to manage and own the business. Succession planning may include the development, training, and support of successors and the delegation of responsibility and authority to them. Proper succession planning ensures a smooth transition and continued operations after the death of the grantor.
  • Key person insurance: Also known as key man or key employee insurance, this type of insurance provides a financial safety net for a business if the death or disability of a key employee, such as the owner, negatively impacts the company’s revenue and operation. Key person insurance is designed to assist with financial losses during the employee’s absence or replacement.
  • Life insurance: Life insurance is an essential part of many estate plans, especially for business owners. Life insurance can offer immediate liquidity to satisfy estate taxes, buy out the owner’s portion of the business, or support the grantor’s family after death. Choosing the right type of life insurance depends on the grantor’s unique needs and goals.
  • Medical power of attorney: Also known as a healthcare proxy or durable power of attorney, this individual is appointed to make healthcare decisions on behalf of the grantor in the event they become unable to make those decisions themself. Business owners with an appointed medical power of attorney help to ensure healthcare decisions are in accordance with their wishes and do not burden the family or business partners with making those choices on behalf of the grantor.

Why is Business Valuation and Liquidity Important in Succession Planning?

Accurate planning of a business’s future relies heavily on determining its value. Valuation is a complicated process that involves the value of business assets and potential earnings. Other factors of valuation include goodwill, industry trends, and company reputation. A financial advisor or professional business appraiser can ensure an accurate valuation. 

A major challenge for business owners is ensuring liquid assets for future needs, particularly the future needs of the owner’s children and other beneficiaries. A lack of liquidity may result in a forced sale of the company at an unfavorable price.

To create liquidity for an estate sale, the following options should be considered:

  • Diversification of investments: A diverse investment portfolio outside of the company will allocate resources to various investment methods, minimizing risks and providing alternative sources of income.
  • Evaluation and implementation strategies for creating liquidity: Options for creating liquidity include retained earnings, life insurance, or a buy-sell agreement with a predetermined buyer. A financial advisor can help determine the best strategy for each situation.
  • Planning for the transfer of ownership: A clear succession plan can avoid disputes among beneficiaries or shareholders and ensure a smooth transition for the business.

What are Tax Minimization Strategies Used in Business Succession Planning?

Business owners who are concerned about the tax consequences involved in estate planning or succession have many options to choose from, such as implementing trusts and other strategies. Several useful trusts and tax strategies will be discussed in greater detail below.

Irrevocable Life Insurance Trusts

An irrevocable life insurance trust is useful for managing estate taxes. It places a life insurance policy within the trust that excludes the death benefit proceeds from the taxable estate. This type of trust can help reduce the overall estate tax liability and offer liquidity for beneficiaries to pay any taxes in a timely manner. An irrevocable trust cannot be changed once it is created and requires relinquishing control of the life insurance policy.

Grantor Retained Annuity Trusts

A grantor-retained annuity trust transfers appreciating assets to beneficiaries while minimizing gift and estate taxes. To establish this type of trust, the grantor must transfer assets to the trust and will retail the right to receive annuity payments for a fixed period. After the period ends, the remaining assets within the trust will pass to the beneficiaries without gift or estate taxes. To be effective, the grantor must outlive the annuity period.

Avoiding Probate

For business owners with significant assets, probate can be an especially lengthy and costly process. Establishing trusts is one method to avoid probate. Other strategies for avoiding probate include:

  • Ownership structures such as joint tenancy with right of survivorship
  • Beneficiary designations for financial accounts and life insurance policies
  • Transfer on death deeds for all real estate

Do You Need an Attorney?

If you have spent years building your business and are now considering what will happen to it after you are gone, you deserve experienced legal help you can count on. Call the attorneys at Ragab Law Firm, P.C., at 720-776-8853 or complete a contact form to schedule your free case evaluation.