Business succession is one of the least planned stages of most advisor's businesses. I once read that business success was defined as "planning for the exit from a business in a cost and tax-efficient manner which allows the business to be successful afterward" - Thomas W. Abendroth, a partner in Chicago law firm of Schiff Hardin LLP.
Abendroth discussed six themes that he believed were key elements for a successful succession plan:
- Start planning as soon as possible, long before your client has a clear idea for his/her exit plan.
- Build-in flexibility so all necessary changes can evolve with the client's needs.
- A clear division of control and equity.
- Remember to diversify planning techniques.
- Transfer tax savings.
- Include non-tax items such as family harmony as certain members exit while others stay involved with the business.
Some clients may agree to the transfer of equity of a business to the next generation following a succession plan while being reluctant to release control in any form of their business. One good approach to this issue is to change the capital structure of their business. A corporation will create a class of non-voting stock, while a partnership offers limited partner interests, a limited liability corporation creates a class of non-voting member interests. This way the client holds the voting shares/interest and remains in control. The equity value is put into the non-voting shares and passed to the next generation. One of the advantages of the bifurcation of control and equity being set up this way is the generation of valuation discounts for the non-controlling interest.
This is a great solution if your client has children and they need to have some of the children operate the business while others have economic ownership of it. The dependents that operate the business can have voting stock and the non-voting stock can go to their other children. In all instances, if your client has succeeded in transferring the business equity to their children but still has an active role in the business they need to receive compensation for their services. This will help to ensure that the IRS doesn't assume the client is making indirect gifts of their services. This also accounts for any loans the client may guarantee to the business that he or she no longer has enough equity for. Just to make sure to avoid any issues with the IRS a guarantee fee should be paid to the client.
It would be beneficial to hire a business appraiser as early as possible in the succession planning process so that all family members can be informed about proper valuations and valuation discounts. If family members are planning on exiting the business it is important to consider compensating those family members since they are forgoing health insurance, free company products, travel budgets, and the like.