Business Law: Why Is Business Succession Planning Important?

One of the most difficult, yet likely most important, things to grapple with as a business owner is what happens to the business if you are incapacitated or pass away while your business is active. How will employees get paid? How will contracts get fulfilled? Who can manage the business while you are out? How do you pass the value of the business to the next generation? Interestingly, that last question is the one that many skip over… many business owners underestimate the value of their business because they assume that once they are gone, the business will also be gone. And even when there is a transition plan in place, often times the value of the business is completely exhausted within one or two generations of the founder.

That said, just because it is hard and forces the business owner to handle issues that seem daunting, it must be done. Here is a real-life example of the chaos that ensues when a business has no succession strategy in place:

Business Owner has a successful manufacturing business formed as a single shareholder S-corporation that has earned large, ongoing government contracts. He has one family member that works in the business as a blue-collar worker. The financial affairs of the business are handled by a bookkeeper. The Company has 20 full-time employees, one of whom has an active worker’s compensation case.

Business Owner passes away unexpectedly and intestate (meaning: without a will or a trust) at the age of 50, leaving no wife or children. He is survived by 4 siblings, one of whom is in prison for serious criminal conduct. Two siblings are older, retired, and had blue collar jobs when they did work. The last sibling is retired and worked at a government job. Not one of them has an entrepreneurial spirit like the deceased Business Owner.

Nevertheless, one of retired siblings becomes administrator of estate and is attempting to manage the business to obtain top value, but has no experience in the business and, as mentioned, is retired! The family member that had been working in the business prior to the death of the Business Owner wants to keep the business, but there are concerns about this family member’s business acumen. He also lacks the funds to pay the price tag for the sale of the business.

To add fuel to the chaos, Business Owner owns underlying real estate where manufacturing is conducted, but not in the name of the corporation and there is no lease on the property. Basically, there is NOTHING in place to keep the business afloat, yet there is over $1.0 million in value for the beneficiaries if the personal representative can keep the business moving forward.

What happens to the business when Business Owner dies?

That is just it – there is no clear plan. California law regarding intestate succession will give the business to the four siblings unless they wish to sell it. The problem is that NONE of them are qualified or have the wherewithal to run the business. Think this story sounds outrageous? It is not, and it is the all-too-familiar scenario we handle after someone dies or becomes incapacitated.

The moral of the story is that a lack of plaining caused CHAOS and lost value to the heirs of the deceased business owner, insecurity to employees (and loss of key employees), and potential lawsuits from unfulfilled contracts if no one is able to step in and complete the contractual requirements. Unfortunately, this failure to plan is most common amongst small businesses who have few shareholders (3 or less), regardless of total revenue of the business.

What is Business Succession Planning?

Business Succession Planning is simply the process by which we plan for an owner or owners of a business to transition their business ownership to another and preserve wealth for the business owner, as well as a plan to best preserve the good will, employment of individuals, and goods and/or services already established by the business owner.

What Types of Planning?

Unfortunately, this is largely dependent on the business owner and who, if anyone, may be a suitable choice for a subsequent owner. Usually involves a buy-sell agreement with another party upon certain triggering events (death, divorce, disability, retirement). At a minimum, however, there should be a power of attorney or some type of emergency plan for who can manage the business even in short term disability situations.

Who Should be Involved?

Business succession planning implicates many important issues, which makes it critical that the business owner’s team of professions work together to create the overall plan. A CPA will usually need to be consulted, especially if there is going to be a sale of the business in advance of death. A financial advisor should discuss the financial security of the business owner – some business owners will annuitize the business and continue to receive monies from the business after they retire. An insurance agent selling life insurance to fund the buy-sell agreement are also often involved. And, of course, POOLE & SHAFFERY, LLP should serve as the legal advisors drafting and/or negotiating the agreement that will govern this transaction.