Succession Planning: Structuring a Successful Plan With Tax and Non-Tax Considerations

No business should operate without a succession plan in place. The succession plan should have its imprint on the day-to-day operations of the business. Once you have a succession plan in place, the implementation of that plan will integrate itself into the fabric of decision making. Importantly as well, the timing of your succession will become real and tied to something other than a loose idea of someday transitioning out of your company.

If you work with Lobb & Plewe in putting your succession plan together, the initial step will include a detailed conversation regarding the possible avenues of succession. As an owner you may have already decided that family, a strategic buyer, a private equity firm or the employees, will end up owing the company. If preliminary determinations have not been made, all of the options will need to be reviewed. Once basic details have been discussed, L&P will start the draft of a Business Succession Plan (BSP) which is discussed in more detail below in this article.

Some of our clients are business dealers who buy and sell companies as a business plan in and of itself. Their succession plan consists of building up a business as an asset in a short period of time and then selling it for a set desired profit. This article does not directly address those business owners. The focus here is on those business owners who have a primary business as an asset which they have owned for a long time. They are not in the business of buying and selling businesses. There are common themes between the two, such as the need to build up EBDITA (earnings before depreciation, interest, tax and amortization) and recurring revenue, but the dealer of businesses works under a different paradigm which goes beyond the scope of what is addressed here.

At Lobb & Plewe we have a working platform we have put together called a Business Succession Plan as mentioned above. This BSP was created by our firm as a tool to use to tie out all of the issues a business owner will incur when putting the succession plan in place. It is a working -breathing document which will go through many edits as the plan comes together. It integrates the tax and non-tax considerations in detail. Below are some of the issues addressed in the document:

Non-Tax Considerations:

The primary non-tax issues involve (1) the composition of your professional team, (2) timing, (3) price, and (4) the composition of the management team.

You need a strong professional team to assist you. Let your CPA and business lawyer know you want to put a succession plan in place and make sure they are the right professionals to assist you. As you proceed in putting your succession plan in place, you will likely engage a financial planner, business valuation expert and an investment banker or business broker. Depending upon the route you take, you may also end up consulting with a family business transition expert and ESOP experts.

The timing of the disposition of your company is a key element in putting the BSP together. In order to analyze the timing issue, you need a financial plan if proceeds from the sale of the company will be funding some of your retirement plan. You need to know how much is needed out of the liquidating event to determine many things such as the feasibility of selling the company, along with the minimum acceptable sales price. You may have sufficient other assets to retire, but the financial plan provides significant insight into how the sale proceeds will be integrated into the owner’s financial world which in turn dictates the timing of the sale.

You need to make sure the EBDITA is sufficient to yield the return necessary to fulfill your financial plan. If a normal annual growth of your company will allow you to reach the desired sales price in five years, but economists are predicting a recession in five years, you may have a problem. You do not want insufficient EBDITA and weak capital markets when going to the market to sell your company. Going to the market to sell your company in 2009 was likely not ideal. As usual, good timing is everything. Good planning is critical.

There are other variables to take into consideration as well in determining when you are ready to go to the market. For instance, if you are a “hands-on” CEO, the business as an asset has diminished value if you are gone. Thus, you need to build up your management team and start grooming the future CEO. Often, some members of the existing management team are older and will likely retire when the CEO is gone. Thus, some of the top people may need to be replaced. Many other issues loom and all of the issues will take some time to resolve.

Your BSP will tackle all of the issues above in detail and incorporate a timeline for the resolution of issue, training of necessary management, necessary growth matrix to reach desired EBDITA and much more. It will be your guide moving forward.

Tax Considerations

How much of a net, after tax return are you seeking for your business? As mentioned above, you need to determine this number before you can begin to pin the acceptable sales price. There may be other factors which drive the price you desire for your company, but if the proceeds are tied to your retirement, you need to know the number that works for you.

Once you have settled on a net after taxes number resulting from the sale of your company, you need to determine how to price your company. A starting point is to obtain a valuation from a valuation expert for the company. You need to know the current market value of your company to put your plan in place. Also, you need to study the valuation report once it is made available so you can see what issues are causing the value to be depressed and what value drivers you need to focus on moving forward. The report will provide you with valuable information. You should provide the report to your professional team and meet with them to review it and discuss the implications of the report to your succession plan.

There are many tax issues which need to be analyzed. Aside from fully understanding your EBDITA, you need to understand how the existing entity structure will be taxed upon a sale. Review these issues well in advance of making definitive decisions on how you will price your company.

As an example, if your company is structured as a subchapter “C” corporation you may desire to structure the sale of your company as a stock sale and not an asset sale. Depending upon the year in which your company was capitalized and the stock was issued, if your company qualifies as an active trade or business, the sale of stock may be completely tax free. If the sale will be tax free then you will have flexibility in the sales price.

If intellectual property is held outside of your main operating company, you will need to analyze any tax issues which may arise if the prospective buyer wants those assets rolled into the main operating company before a sale, or how those assets will be taxed if they are sold separate from the main operating company. Integration of those intellectual property assets into a non-grantor trust structure in advance of a sale should also be analyzed.

If you own a subchapter “S” corporation, you will need to understand how a buyer may approach a purchase of your company and how the various purchase structures will be taxed. For instance, it is common for a buyer to request what is referred to an “F” reorganization or QSUB dropdown prior to the sale of the company. If you are selling to private equity, this likely will be the path and you will need to have an idea of how the sales proceeds will be taxed under such restructuring.

In putting your BSP in place, you will want your CPA and corporate tax lawyer to review your most recent personal and business tax returns to make sure they understand the tax attributes which may come into play if your company is sold or if you are better off if you proceed with an ESOP. You have to fully understand how the sales proceeds will be taxed and tax modeling should be done so you will have a true vision of how the net proceeds will affect your financial plan. All of this should be set forth in your BSP.

Concluding Comments:

Do not be concerned about being “right” during the early stages of succession planning. There is no “right” in the beginning. All things may change. Many pieces to your plan will change in some fashion along the way. A ten year plan may well become a six year plan. Your irritating teenage child today may end up graduating from the Wharton Business School and want to be the next CEO. The important thing is to get the ideas in place and start executing the plan. As things change, adjust the plan and keep moving forward. Do not end up in your middle to late 70s wondering how and when to deal with the succession of your company. Make that determination today and get your plan in place. A platform integrating the tax and non-tax elements of succession such as a BSP is the right place to start putting the plan together

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