By Abigail Neal, Arizona small business lawyer
Small businesses, meaning those businesses having less than 500 employees, make up 99.9% of all businesses in the United States. The owners of these small businesses will someday leave their businesses as a result of retirement, incapacity or death. But most small business owners are so busy working that they don’t make the time to think about business succession and estate planning issues. This is one of the big reasons that less than 1/3 of family businesses survive to the second generation, 65% of those fail to survive the second generation, and 90% of family businesses fail to survive the original business owner’s grandchildren.
Often people neglect to meet with their business attorneys who actually play a huge role in helping business owners plan for what is usually their largest asset – their business. All too often we meet a business owner who is so busy doing his job that he forgets about planning for the business. Many business owners wonder if they will ever be able to retire, who might take over the business, if the owner can get retirement income without going out of business, and what would happen to the business (and the business owner’s family) should he prematurely die or become incapacitated. But unfortunately, most small business owners do not give these things serious attention until they are ready to retire. That’s when they realize that if they had done more to plan for their business and prepare for its succession they could have achieved better results.
We can help you change your focus from how much you are making today to thinking about the future rewards you can reap by planning for your family and your retirement today.
Two Tips to Get Started with Business Planning
Two tools that are often not used by business owners can be helpful:
The Year-End Review: This helps you see how the business has performed over the last 10-11 months, review the business’ profitability, and plan for the coming year’s tax situation. A common way to start a year-end review is considering ways to reduce taxes in the coming year. This is also a good way to start thinking of business continuity issues.
The Legal Audit: This is a review of all legal documents of the business, including organizational documents, employment agreements, leases, loan documents and guarantees, and buy/sell agreements. It provides another opportunity to look for tax savings and a way to identify potential gaps or liabilities. A yearly legal audit is also the perfect time to talk to your lawyer about business planning and planning for the eventual transition of your business.
Providing the data for these two reports and reviewing them with your CPA and business attorney will help force you to stop and examine business growth and profitability and talk about continuity issues.
Step One: Identify Your Motivation and Goals
As Dr. Laurence J. Peter, the man who established the famous “Peter Principle” said, If you don’t know where you’re going, you will probably end up somewhere else.” In order for you as a small business owner to avoid ending up “somewhere else,” you must establish goals for yourself and your business.
Learning what motivates you like income, wealth, identity, challenge, stimulation, satisfaction and/or pride, will help you determine your goals will help you clarify priorities, avoid quick fixes, move forward by identifying a desired outcome, and focus energy on the most urgent concerns.
Typical business owner’s goals include the following:
* Create and preserve the value of the business
* Exchange that value for money with the least amount in taxes
* Meet personal and family needs by providing security and continuity of the business in case of the owner’s premature departure
* Leave a legacy
* Give money to charity
* Shift wealth to children
* Reward key employees
* Receive full value for the business
* Keep the business (or sell it) at his exit
* Take the business to the next level
Step Two: Value the Business
Most small business owners have no idea what their business is worth, but you will need to know the value if you ever anticipate a sale to a third party buyer. In the meantime, knowing what your business is worth will help you with projecting your business’ cash flow, estate and gift tax planning, knowing how much insurance to purchase, preparing buy/sell agreements, compensation planning, knowing available collateral for financing, and better understanding your retirement planning. It also helps you monitor your progress toward your objectives.
Step Three: Plan for Business Succession
Many small business owners are too busy to think about what will happen and how the business will continue when they retire, or if they become incapacitated, die or sell the business. Most small business owners we meet want their business to survive with the person they choose to receive their ownership interest in the business. Likewise, if one owner “departs” for whatever reason, the remaining owner(s) will usually want to retain ownership and control and do not want to be in business with the departed owner’s creditors, surviving spouse and/or heirs. Business succession planning can include preparing documents like buy/sell agreements, employee purchase agreements, deferred compensation agreements, 83(b) elections, stay bonus agreements or asset purchase agreements.
Protecting all of your hard work, yourself and your family is the the reason every business owner should have a business succession plan.
Step Four: Plan for Personal Wealth Preservation and Succession (Estate Planning) and Asset Protection
Almost every small business owner’s objectives are to preserve wealth and minimize taxes. This can be done using both lifetime and death planning tools. Where a family business is involved, this requires combining business succession planning with the business owner’s estate plan. As such, estate planning becomes a critical part of business succession planning.
Business owners will typically often want to address the business planning first. Once you clarify your goals and develop a plan for your business, you will see that your estate plan has already started to take shape.
When you prepare your estate plan, you should consider the growth of non-business assets, how to be fair to your children both inside and outside of the business, minimizing any estate tax and having the cash to pay the tax if necessary, asset protection during the your lifetime and for your heirs, avoiding probate, planning for long term health care costs, and other special considerations, such as planning for pets or a family member with special needs.
Step Five: Grow and Protect Business Value
From the owner’s perspective, growing the business and protecting its value will maximize the amount realized on the sale of the business, protect assets from potential business and personal creditors, create the ability to sell the business, and motivate and keep key employees and family members in the business.
Promoting the value of a business includes increasing cash flow, developing operating systems (so that the system, not the owner, becomes the solution), documenting sustainability of earnings (if the owner is taking all the cash out of the business, it will be harder to sell), improving company performance as measured by industry metrics, and paying down debt.
To grow the business and protect its value, it may be necessary to restructure the organization, solidify and diversify the customer base, implement strategies to grow the company, develop and protect proprietary technology, build a solid management team, and groom a successor.
It may also be worthwhile to examine and possibly change the corporate structure (S and C corporations, LLCs and partnerships). Your business attorney can help you consider tax pros and cons, ease of operation and asset protection features of each type of entity.
Asset protection is an important part of growing and protecting your business value. However, most business owners don’t think about asset protection until a claim arises. Keep in mind that the best time to plan is before the protection is needed. Talk to your business lawyer about asset protection for both business and personal assets early in the planning process. You may want to consider an umbrella policy as is an inexpensive start toward asset protection of both business and personal assets.
Step Six: Business Ownership Transfer
The ability to sell and the value of the business are both affected by intrinsic factors (e.g., how the business has grown), extrinsic factors (e.g., the local and general state of the economy), and the effectiveness of the sale process. There are only two basic types of ownership transfers – to those who are in the business and to outsiders. Each has special characteristics:
Sale to Outside Buyers (Third Parties): The benefits for the business owner of a sale to an outside buyer can include cash at closing, no owner financing (which eliminates financial risk), no family succession issues and the speed with which the exit can occur. However, everything must come together just right to successfully complete the sale of a small business. Far more often than not (often as a consequence of failure to plan properly), no buyer can be found who is willing to pay the owner’s price. About 20% of businesses are offered for sale, but only one in four of those actually sells. The probability of effecting a successful sale changes with the size of the business. About 1/3 of businesses with annual sales of $10 million or less sell while about 1/2 of offered businesses with annual sales over $10 million sell. As part of a business owner’s succession plan, it is important to remember that it can often take years of proactive planning to successfully prepare a business for a sale to an outside party.
Sale to Children or Key Employees: The business owner’s succession objective may be selling the business to children and/or key employees. This can motivate and help retain key employees and family involvement in the business. Money for this type of sale usually has to come from the ongoing business, so planning is critical to help reduce risk of buyer default and to increase the amount of money received by the owner.
Depending on the health of the business and the objectives of the business owner, it can take several years of planning and action to implement a business succession plan and get the other planning in place. A forward thinking business owner should meet with a business attorney to initiate the planning process long before an anticipated succession event.
Powers & Neal Can Prepare Your Comprehensive Succession Plan
No two business succession plans are alike because every business is different and every business owner’s objectives are different. We can help all types of small businesses prepare for their succession – both personally and for the business. A comprehensive succession plan includes preparing an estate plan and business succession plan that details what should happen if you were to pass away or become incapacitated. An estate plan will also deal with the transfer and management of assets, guardianship of minor children, end-of-life wishes and may potentially avoid probate. A business succession plan should also address plans for the business owner’s retirement and the transfer of the owner’s interest in the business to others. Call Abigail Neal today at (480) 699-7992 and learn how we can help you create a comprehensive plan for yourself and your business. We offer buy-sell agreements, asset purchase agreements and more for a low flat fee.
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