Successful Succession Planning

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The unexpected death or disability of a business owner is difficult waters for any business to navigate. Family members, customers, vendors, and employees all have a stake in the continued viability of a business affected by an unexpected death or disability.

It is important, therefore, that every business owner have a succession plan in place to address these potential events. A succession plan should not only address the legal and tax consequences raised by a death or disability, but should also address management succession issues.

The starting point for a successful succession plan is understanding the owner’s goals and objectives and addressing contingencies such as an unexpected death or disability. From the legal perspective, each business owner should have a “basic” estate plan.

A basic estate plan consists of a last will and testament, a durable general power of attorney, and a healthcare power of attorney. Your particular situation may warrant the use of trust agreements and other planning techniques, but these three documents are the base of any plan.

A durable general power of attorney will appoint one or more agents who can make decisions in place of the business owner who is incapacitated. A last will and testament appoints a personal representative who has the authority to wrap up the affairs of the deceased owner.

The authority of your agent will be set forth in your power of attorney and the authority of your personal representative will be set forth in your last will and testament, but it is important to understand that the owner’s agent or personal representative will “stand in the shoes” of the owner and therefore is bound by any contracts the owner makes during her lifetime, such as a buy-sell agreement.

A business owner only has one last will and testament that covers both their business and personal lives. However, a business owner can have a “business” power of attorney and a “personal” power of attorney. The substance of the power of attorney will generally not be affected by the type of business (LLC, corporation, etc.).

Your estate plan documents are one part of your succession plan. A succession plan also should provide a clear understanding of which employees or other owners will assume the responsibilities of the deceased or disabled owner.

Employees, customers, and vendors need to be assured through continuity of management that their relationships with the business will not be affected by the death or disability. This part of the succession plan can be laid out in some written format, such as an “emergency plan” or an agreed-to directive to the management team and other owners.

As noted above, the owner’s agent or personal representative will “stand in the shoes” of the owner. Therefore, in the event of a death or disability the agent or personal representative will have the right to exercise any voting rights associated with the ownership interest unless there rights are otherwise limited by contract.

For example, the agent acting on behalf of a shareholder/owner could vote the owner’s shares to elect different members to the board of directors, which could be unsettling to third parties.

Most succession plans incorporate life insurance and disability insurance. These insurances will replace lost income and provide financial resources to carry out the sale of the business—the disability policy can provide a lump-sum benefit to one owner to be used to buy out the disabled owner.

Disability insurance generally is designed to replace a business owner’s lost income. It also may be used to fund the purchase of a disabled owner’s interest in the business.

For example, if there are two owners (A and B), then A would own life insurance that insures B’s life, and vice versa. In the event of B’s death, A could collect the death benefit and would use the death benefit to purchase B’s interest in the business. The ownership of the life insurance and the purchase and sale upon death would be required by the buy-sell agreement of A and B.

In addition, the owner should assess whether “key person” insurance is needed to provide the business with working capital or whether additional life insurance is needed to pay off debt. The amount and types of insurance needed should be analyzed by the owner’s team of professional advisors.

It should be noted that succession planning is particularly important for the creditors of your business. Banks that have extended credit will be keenly interested in your plan if there is an unexpected death or disability because a lack of a plan may jeopardize repayment.

Also, a personal guaranty of a loan may be in default upon the guarantor’s death, regardless of whether the business continues to pay the debt, which can give the creditor newfound leverage.

A business with more than one owner should have a buy-sell agreement between or among the owners to establish how the interest of the deceased or disabled owner will be transferred. A 100 percent owner will need to identify employees or other parties that can purchase the business. In all cases, the buy-sell agreement should address various issues such as:

  • How long must a disability exist or how severe must it be to trigger a sale obligation?
  • Will there be seller financing?
  • If there is real estate, is it sold as well?

Seller financing often is required but presents a variety of issues that must be considered.

First, how much of a down payment will be required, if any? What amount of interest will be charged? How long will the loan be amortized, and will there be a call date before the end of the amortization period? What collateral or guarantees will support the financing? Will distributions and compensation of the owners be limited as long as the financing exists? What happens if the purchaser subsequently sells the business?

As outlined above, succession planning is not an easy task and often involves competing considerations. However, the worst plan is no plan at all, so each business owner is benefited by taking the time to work with her professional advisors to develop a plan that suits the owner’s needs and concerns.BW

Vance E. Antonacci is a member of the law firm McNees Wallace & Nurick LLC practicing out of the firm’s offices in Lancaster and Harrisburg. For more information about business succession planning, email or call 717.581.3701.

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