Keys To Business Succession

RogersFamily business succession planning is important to address well before it is needed, and possible changes to the Internal Revenue Code may provide yet another reason to address this topic with a trusted advisor sooner rather than later; especially for individuals whose assets approach or exceed the federal estate and gift tax exemption limits. Following is a review of key succession planning considerations and a summary of anticipated restrictions to valuation discounts often used in such planning.

Five Key Succession Planning Considerations

  1. Have an estate plan and keep it current. If no other succession planning is done, the estate plan, at a minimum, documents the owner’s assets, how those assets are to be administered and distributed upon the incompetency or death of the owner, identifies trusted decision makers, and effectuates the transfer of the owner’s assets to the beneficiaries.
  1. Review all company documents. An owner should take stock of the names of the documents, whether the originals can be located, and when the documents were last reviewed. Pertinent to succession planning is whether the operating agreement (for an LLC) has transfer provisions or the corporation has a buy-sell agreement. Even (and especially) if the business is a partnership or sole proprietorship, the owner should review any documentation for provisions that address the transfer of ownership.
  1. Contemplate the effect of major life events. How would the owner’s life and those of any dependents (family or employees) be affected if the owner died without doing any further planning, was disabled and could not run the business, or became divorced and had to finance a settlement owing to an ex-spouse? When may the owner desire to retire (if at all)? Are any family members interested in and able to purchase and continue the business? A plan and documents can be drafted for each event.
  1. Begin with management succession. Prior to transferring ownership (and certainly before relinquishing control) of the business, a business owner should allow the prospective successor to step into a management role. This will test the successor’s ability to run the company, and allow the successor to learn from the owner. Plus, a transfer of management responsibility is more easily withdrawn than ownership if the owner questions the successors approach or ability.
  1. Review the planning. After implementing a succession plan, the business owner should take the time to revisit it upon the occurrence of significant events (deaths, maturing children, loss of a key employee, major expansion). Anticipated changes in state or federal laws, like the proposed regulations pertaining to valuation discounts discussed in greater detail below, may also prompt a business owner to review the business succession plan in place.

Common Succession Approach; Anticipated Valuation Changes

One common estate and succession planning tool is the family limited liability company (FLLC). In a typical scenario, the parents would create the FLLC and transfer investment assets, real estate and/or the family business to the FLLC. They would then decide when to gift the membership interests in the FLLC to their children or grandchildren.

This approach consolidates the management of numerous family assets, affords a level of liability protection, and provides for an intentional and controlled transfer of wealth to the younger generations. For the time being, using an FLLC may also permit the parents to reduce transfer taxes incurred while keeping the business in the family by utilizing certain valuation discounts.

Two restrictions often used in FLLC planning that may be restricted by proposed new regulations are “lack of marketability” and “lack of control.” The loss of those restrictions could result in higher valuations of gifts of family limited liability company interests, which could in turn result in more transfer taxes paid by the older generation and fewer assets transferred to the younger generation.

The exact scope of the anticipated proposed regulations is unknown at this time. Other possible implications could be: Will they apply to entities holding passive investments or as well as to active businesses? When will they take effect? Will they apply to transfers to non-family members?

Even if the FLLC approach (and any valuation discounts resulting from the transfer of membership interests therein) is inapplicable to a business owner’s situation, it is still wise to address estate and succession planning early to preserve the value of the business and ensure it is transferred to the desired successors. Business owners should speak with their trusted counsel to implement a plan and stay abreast of changes in the law.

Chris Rogers is an associate with Kuhn Rogers PLC in Traverse City. His legal career is focused on estate planning, business succession planning, real estate law and general civic practice.