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Top Ten Business Succession Planning Mistakes

on Monday, 2 November 2015 in The Closer - M&A, Securities and Corporate Counsel: Kevin P. Tracy, Editor

As business owners approach retirement age, many begin to focus on the next phase of their business – one that does not involve them. This article describes some of the major planning gaps common to business owner’s succession plans.

1. No business succession plan. Most business owners are experts in the operation and growth plans for their businesses. Many business owners, however, have little or no business succession plan in place. A good starting point for a business succession plan involves answering the following questions: who is intended to be the successor? – what are the steps required to complete the succession process? – when will the business succession take place? – where do the funds come from to buy the business? – why choose one business succession option over another? and, – how is the value of the business determined?

2. Waiting too long. Too many business owners approach the succession of their business with the mentality: “When that day comes, I will sell my business and retire.” However, there may not be sufficient time between the date the business owner realizes they want to retire and the date of their intended retirement. Many business owners experience some “life event,” which triggers the need to start thinking about the succession of their business. Such life events include unexpected health issues or the death of a loved one. In most cases, it is a good idea to put a business succession plan before the life event occurs, ideally at least 10 years prior to retirement.

3. Business is “too linked” to the owner. Unfortunately, not every business has a buyer. It is especially difficult to sell a business that is based primarily on the work and customer trust of the original business owner. A goal for a business owner is to “create a market” for the business – which takes time. The business owner should work to develop customer relationships with other employees in the business. Many business owners are reluctant to share the customer relationship in order to protect the business from an employee who could terminate their employment and open a competing business. With a proper non-compete agreement in place with employees, the business owner may be afforded some protection against this unfair competition.

4. How do you handle children who are not involved with the business? Does the succession plan involve children? Many business owners have children who are involved with the business and children who are not involved with the business. Some business owners avoid succession planning because they do not know how to resolve this dilemma. Avoiding those conversations with family members may be the cause for failing to plan for business succession. One solution to this issue may include actually treating children differently under the succession plan by separating the stock of the company into voting and non-voting shares (children have equal equity, but the children who are engaged in the business maintain voting control).

5. Stock vs. asset sale. There is typically a difference between the purchase price for the assets of the company and the purchase price for the company stock. Most buyers want to buy the assets of the business, whereas most sellers want to sell their stock. Under an asset purchase arrangement, the buyer is only buying assets – specifically excluding business liabilities and debts. Under a stock purchase arrangement, the buyer is buying the entire business – assets and liabilities. It is important to compute the purchase price under each arrangement and negotiate based on this information. Many business owners fail to determine which transfer approach is best for their own circumstance.

6. Wrong entity – C vs. S or LLC – 10 years. Most closely held businesses organized before 1960 were C corps. Sale of assets from a C corp. are taxed twice; first at the ordinary income level of the corporation, then taxed as the sale proceeds are distributed to the shareholder. S corps and LLC’s usually are only taxed once. As most buyers are interested in purchasing a business as an “asset purchase,” planning can help a business double taxation, but it takes significant planning and time to convert a C corp to an S corp or an LLC (10 years to convert a C corp to an S corp).

7. Bad financial information. It is common to operate a business so as to show as little taxable income as possible. When it comes time to transfer the business, the potential buyer is commonly looking to compute the purchase price based on earnings. In the years preceding an intended succession of the business, it may be important to carefully review the operations of the business to record the business profits in such a way as to demonstrate earnings of the business to a potential buyer. The financial statement review by a potential purchaser may include as little as three years and as many as five years of financial information.

8. How will the purchase price be paid? Trying to sell a company with a significant amount of debt may impact the buyer’s financing options. If there is no leverage inside the company, it is likely that the business owner will be asked to become the lender for the sale transaction.

9. Income and benefits. Business owners may wait too long to make a transition of their business because they need the income and benefits. However, income and benefits may be part of the succession plan, thereby allowing an earlier sale to occur. Business owners may be retained by the new business owner for a number of years as an employee or independent consultant. Under these arrangements, the prior business owner may be paid either as an employee or as an independent contractor. In addition, if the business is separated from the real estate (the building), the former business owner may continue to receive income under the lease of the building to the new business owner.

10. No estate plan. The succession plan needs to coordinate with the owner’s estate plan. If the owner dies before the company is sold, the estate plan becomes the succession plan.

Michael C. Schilken

1700 Farnam Street | Suite 1500 | Omaha, NE 68102 | 402.344.0500