What Should Be in Your Business Succession Plan?

The statistics on transferring ownership interests of family-run businesses suggest that it’s quite difficult for a company to survive the second generation. In almost every case, the lack of a strong business succession plan is the culprit. 

Business succession planning is the internal and external procedures for passing on one’s business to the next owners. For family-run businesses, this often involves the owner selling or gifting the business to sons, daughters, or other loved ones. No matter who your successor is, effective planning is the best way to achieve your goals.

Buy-Sell Agreement

Companies with three or fewer owners often have buy-sell agreements (sometimes called buyout agreements) in the organizing documents. A buy-sell agreement stipulates the method of transferring the ownership interests if one owner dies, retires, or becomes incapacitated. The agreement usually requires the other owners to have “first crack” at the available ownership interests and lays out the valuation method. 

Business owners who might not have enough liquid assets to buy out another’s owners interests take out a life insurance policy on the other owners. After one owner’s death, the payout gives the other owners enough capital to execute the buy-sell agreement and purchase the ownership interests from the decedent’s surviving family members. Another important function of the buy-sell agreement is delineating the obligations of the surviving owners. 

Passing the Business to an Heir

One of the best ways for California entrepreneurs to provide financial security for their loved ones is by passing on their ownership interests. Before you decide to go that route, you should make sure your son, daughter, or other younger family member is truly interested in running the operation. After you get that confirmation, you should execute a yearslong internal process of transitioning ownership/management to your heir. 

After you identify your successor, you and your lawyer need to decide how to legally transfer ownership. Some business owners transfer their business through a Last Will and Testament, but this can leave estate planners vulnerable to federal estate taxes (California has neither estate nor inheritance taxes). 

Other business owners choose to transfer their ownership interests to a living trust; this allows owners some amount of control and financial benefits from the company during their lifetimes. 

Still others “gift” portions of their companies to heirs during their lifetimes. Federal rules allow each donor to gift $15,000 worth of assets to a beneficiary per year without triggering taxes. The lifetime gift exclusion is identical to the estate tax exemption ($11.7 million in 2021). This means that donors can gift up to $15,000 per year, up to $11.7 million total, without having to pay gift taxes. Couples can often double these exemptions. 

So, while there is nothing inherently wrong with passing a business to an heir through your Will, doing so during your lifetime may be more tax-efficient. 

Executing a Business Succession Plan Takes Years of Planning and Hard Work

Few things are as gratifying as passing on a successful family business to your children and loved ones. It doesn’t happen by accident, though. The logistical considerations for passing on your business are almost too numerous to count, and that hardly touches the internal logistics of ensuring continuity of your enterprise’s success. 

Attorney Tyler Q. Dahl is focused on helping California entrepreneurs efficiently pass their business to the next generation. As one of fewer than 100 attorneys nationwide who is also a Certified Tax Coach, Attorney Dahl can help you save taxes along the way. Contact our team to schedule a consultation today

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Dahl Law Group

At Dahl Law Group, we’re not just a law firm. We’re your trusted advisor for your business and family from beginning to end. As your family and business grow, we will be there by your side. Our passion is providing you with peace of mind and protection through personalized estate and business planning.

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