The longevity of a small business depends on a well-thought-out succession plan.
For a family business, you want to evaluate who else can run the business and whether you have to look beyond family members as the business grows.
An experienced attorney can help the key stakeholders create a succession plan or review your existing plan.
If you want to choose a successor, here is a basic how-to-guide to help you get started:
1) Think about who your successor should be. This is an important decision that shouldn’t be taken lightly, and should be on your radar at least 15 years before you expect to retire. Consider who within the business is most qualified to lead going forward. Get some professional guidance, especially if you have a family business, where emotions run high in transitions.
2) Create a timeline. Decide well in advance when the control of the business will shift to your successor. Be flexible and open to your successor’s suggestions and ideas for the business during the transition.
3) Set up a training plan. Define the main areas of the company, and give your successor time to work in all of them, from the highest executive level parts of the business to the most basic tasks. Work with your successor to strengthen his or her understanding in any areas of difficulty.
4) Lay out your own plans for retiring. Having a plan for your retirement will make succession much easier and give both your successor and other members of the team clarity about what’s next and when.
5) Execute the plan and exit. When the time comes, step aside to allow the next leader to take over.
Other choices for succession planning
Handing over company leadership to a successor is only one option. Here are some other ways to go about planning for the long-term success of your business after you exit:
Find a buyer. Sell your interest in the company in exchange for cash or other assets. Bear in mind that you might have to pay capital gains tax.
Transfer your interest by agreement. Consult with an attorney to draft a buy-sell agreement that plans for the sale of your interest in the business at a certain time. The buyer agrees to purchase your business interest at fair market value if and when the indicated event occurs, such as at death, when you retire, if you become disabled, or if you get divorced.
Create a Family Limited Partnership for the business. It can be beneficial to create a Family Limited Partnership (FLP) and transfer a family business to it. An FLP is an entity owned by two or more family members that allows each member to buy shares of the business and to transfer assets between family members tax-free. It includes both general and limited partners. General partners bear 100 percent of the liability and control all management and investment decisions, while limited partners don’t have full voting power and don’t share liability. When one family member is ready to leave the business, it’s easy to transfer it to another.
Set up a private annuity. A private annuity allows you to transfer your business interest to a family member or another buyer in exchange for his or her agreement to make periodic payments to you for the rest of your life, or through the lifetime of a surviving spouse. A private annuity has the benefit of avoiding gift and estate taxes.
Transfer your business interest to an irrevocable trust. If you create an irrevocable trust, such as a Grantor Retained Annuity Trust (GRAT) or a Grantor Retained Unitrust (GRUT), you can transfer your business interest into the trust while continuing to receive income for a defined period. When the time period elapses or you die, your interest in the business goes to the beneficiary of the trust.
Transfer your interest using a self-canceling installment note (SCIN). An SCIN is used to transfer value out of an estate with no gift tax cost. Through an SCIN, you can transfer your business to a buyer in exchange for a promissory note with a “self-cancellation” provision. The promissory note requires the buyer to make a series of payments to you until you die, at which point the note and the outstanding balance are both canceled. At that time, the remaining balance is transferred to the buyer tax-free, with no additional payment owed.