Greater Sioux Falls Chamber of Commerce
Business Sense

Strategic succession

Taking steps to secure your business’s future

Business succession plans are a necessary step to protect your family business. The most obvious benefits include avoiding potential family conflict and preserving the family business for future generations. However, less than a quarter of all family businesses have a formal succession plan. As a result, seventy percent of family-owned businesses do not survive into the second generation, and eighty-five percent do not survive into the third generation. Building a plan as early as possible is crucial, however it is never too late to begin planning.

A business succession plan is a plan used to determine how a business’s assets and management positions will be transitioned. A succession plan ensures the family business can continue without significant disruption in the event of a family member’s death or retirement.

Step 1: Selecting and preparing the successors

The first step in implementing a business succession plan is determining qualified successors, which can be a challenging process for family businesses where owners assume their children will take over. To ensure a successful transition, owners must first confirm their children’s willingness and ability to lead the business. If necessary, owners should arrange management training for their children and supplement their skills with key employees. Hiring outside consultants or advisors can help avoid biases and provide objective evaluations. Key employees can be incentivized through compensation arrangements and restrictive covenants.

Step 2: Developing sound management structure and processes

Implementing processes and management structures is essential for a successful business succession plan. This includes developing an organizational chart and management structure, identifying an executive team, and determining their authority. An outside board of directors or advisory council can also be helpful. Protecting the goodwill of the business through incentive compensation structures, evaluating and protecting intellectual property, reviewing important vendor and customer relationships, and formalizing processes are crucial steps to ensure a smooth transition.

Step 3: Structuring the transition

After completing the preparatory steps for the succession plan, the next step is to structure the transition. Non-operating assets such as real estate should be separated from the operating business so that the owner can transfer ownership while retaining the real estate for retirement income. The transition can then be structured as an equity sale of stock or membership interests in an LLC, financed by the owner or sold over time with the owner retaining voting control. The purchase price can be established by obtaining a valuation of the company and incorporating adjustments based on various factors.

Even if the owner is fully bought out, they often stay involved in the business through an employment or consulting agreement for a year or two. A buy-sell agreement should be implemented to restrict the transfer of equity, set out the details of when an owner can be bought out, and provide a mechanism for valuing the company if a triggering event occurs. The agreement should also provide payment terms for how the purchase price will be paid.

Step 4: Estate planning

Updating an estate plan is crucial for business owners. It ensures the proper allocation of assets, including business interests, in a tax-efficient manner. Even if the business ownership has been fully transitioned, addressing the allocation of non-business assets is essential.

In cases where the bulk of the estate consists of the family business, it’s crucial for business owners to consider the use of trusts in their estate planning to reduce estate taxes, protect assets from creditors, and keep the inheritance in the family, while ensuring the child and future generations enjoy the benefits of those assets.

Incorporating a business succession plan into the owner’s estate plan will help ensure that the business can continue to thrive and that the family relationships remain strong. If you have questions regarding that process, the estate planning attorneys at Woods Fuller can help guide you to an answer.

Meet the author

Heath Oberloh

Heath Oberloh is a shareholder with Woods Fuller. His practice focuses primarily on estate planning and business succession matters for owners of closely-held businesses. Families seeking to take advantage of South Dakota’s favorable trust and asset protection laws also seek his advice. He enjoys explaining the many benefits of South Dakota’s laws and developing and implementing plans to accomplish the family’s goals.