Definition: The process of planning for the day a business owner decides to
step down from their leadership role
For years, all you thought about was how to get your business
going. Now that you're actually making money from your idea, it's
time to think about your future. Even though retirement may seem
far off now, it's worth it to think about what issues you may face
once you stop actively participating in your business.
Death and taxes, while inevitable, should not have to be dealt
with at the same time. Savvy business owners need an exit plan. A
succession plan aims to ensure that when you retire or die, not
only will your business continue according to your vision, but your
heirs won't be saddled with a huge tax bill for carrying out your
plans.
There are several reasons to have a succession plan in place.
First and foremost, family businesses in particular need to make
sure they have some kind of succession plan. A succession plan for
a family business should address the following questions: Do you
want your children to take over the business? Some children but not
others? Are your children able to take over the business? Or should
they just own it and someone else manage it? If you die, will your
spouse get control of the business? If you sell your business
outright to your children, will you pay capital gains?
Another important reason to create a succession plan is tax
savings. If you die without some kind of plan in place, estate
taxes start at 37 percent and ratchet up to a whopping 55 percent
fairly quickly. The government gives heirs only nine months to pay
this tax,. The first thing to do in preparation for succession is
to decide who gets the business next. Keeping in mind that there's
a big difference between who runs the company and who owns the
company, be realistic in your choice. If your kids don't want
anything to do with the business, don't force them. An
uncooperative heir can scuttle the whole estate plan after you're
gone.
Once you've made the ownership decision, it's a good idea to get
a business valuation. Most entrepreneurs are shocked to find out
how the IRS would value their businesses. "Highest and best use" is
the phrase most often bandied about. That means that while you
maythink you could realistically get $100,000 for your business
assets, in the eyes of the IRS, they might go for $200,000.
In addition to giving you an idea of what your business is
worth, a valuation provides a good starting point for projecting
what your tax liability would be if you (or your heirs) were to
sell the business. Minimizing this tax liability is at the core of
any succession plan.
And, of course, all succession plans must comply with the tax
code. The good news here is that in the event of your unexpected
demise, there are a few sections in the tax code that might give
your heirs a break. For example, IRS Code Section 303 permits,
under certain circumstances, the corporation to cash out the
owner's stock (upon his or her death) if the proceeds are used to
pay estate taxes and administrative expenses. There's also Section
6166, which allows a portion of the federal estate tax to be
deferred for up to 15 years (with interest) if the estate
qualifies.
If you decide to try to locate someone who'll run your business
as you've run it, don't focus solely on skills. Instead, look at
the candidates' styles. You want people who think like you and feel
like you, even if they don't necessarily have the same set of
abilities. Finally, don't restrict your search for a successor to
outside your company. In fact, the best successors come from inside
the organization. Find somebody in your company who understands
your goals and principles and who the other people of the company
trust. Grooming a successor isn't an overnight operation. Be
prepared for it to take time--even two or three years.
Communication also plays an important role. As the company's
founder, you may have an almost mythical standing among your
employees. You can not expect anyone to fill your shoes in the eyes
of others in the company unless you have personally, convincingly
designated them as the heir apparent. You communicate your choice
by consistently, plainly saying with words and actions that this is
your choice-the person who will run the company after you leave.
This job also takes time, but it will pay off in improved
effectiveness of the person you leave in charge and, with luck,
will lead to equal or even better growth prospects for your company
after you leave.
There are infinite ways to divest yourself of your company. Even
more so than other areas of estate planning, this is a potential
minefield for the novice, filled with such options as trusts,
private annuities and self-canceling annuities. Enlisting the right
professional is of paramount importance.
The myriad options available to business owners in transferring
their businesses to the next generation should not obscure the real
reason for undertaking succession planning. Any plan can maximize
tax savings, but if you don't take into account family dynamics,
you could destroy the business. The basic idea is to shift some of
the ownership to the next generation so that the growth of the
business is not considered part of your estate.
While transferring assets is a legal and financial operation,
transferring control is more psychology-oriented. Your major
concerns when handing over the reins to your successor include:
- Make sure that the successor is clearly seen by other employees
as your successor, not an interloper or pretender to the throne who
can safely be ignored or discounted.
- Make sure that you are really ready to hand over control. An
entrepreneur who lurks around his or her business after ostensibly
handing over the reins is only undermining the effectiveness of the
person he or she has chosen to lead the business. So when you
leave, leave.