Business Succession Planning (“BSP”) can be a crucial part of estate planning that many business owners do not think about. It is a business planning tool for passing leadership roles and ownership on to one or more other leaders/owners. BSP ensures that your business is in the right hands when you retire or if the unexpected happens.
What is Business Succession Planning?
BSP is a business strategy that companies use to pass leadership roles down to another employee or owner (or group of employees or owners).[1] The plan is not a one-time event; it is a contingency plan that is updated regularly (annually or when changes occur within the company).
Generally, there are two types of plans that should be created when forming a BSP: an emergency plan and a long-term plan. An emergency plan is made to address changes that are unexpected, such as when a key person in the business must be quickly replaced. A long-term plan assists the company in planning for changes in leadership that may occur further down the road.[2]
At times, BSP involves training employees in the development of their skills and knowledge of the business. A large business would train mid-level employees on the duties of higher-level employees. For small businesses, older generations may train younger generations on how to run and manage the business.[3] This ensures that, whether a change is unexpected or not, the business is equipped and ready to adapt to change without a major disruption in the operations of the business.
What are the Benefits of Business Succession Planning?
There are many benefits to having BSP in place. Having BSP ensures that if the unexpected happens, the business will continue to run smoothly. BSP creates peace of mind for the owners of the business – that training and/or selecting a successor for every role will guarantee continuity in the business if something happens to a current owner or employee.[4]
Another benefit of BSP can be the savings on recruitment costs. By implementing training and succession plans, current employees of the business can take on higher roles when they become available. In these situations, most of the training is already done, and the employees already have knowledge of the business operations and the company’s culture.[5]
BSP can also provide a level of job security. When employees are given resources that train them for higher-level positions, they often have greater job satisfaction and are more likely to stay because of the incentive of potential promotions.[6]
What are Different Methods of Business Succession Planning?
BSP in any form has the same mission – to make sure the business successfully survives sudden changes in ownership. While the mission is the same, the plan can vary based on who owns the business after the plan is complete. The owners decide in their BSP what method is best for both them and the business. Below are five (5) methods of BSP and how they operate.
1. Passing the Business to an Heir
Leaving a business to an heir is a common method of BSP; however, it is important that the appropriate estate planning legal documents are in place to ensure this plan is enacted. The advantages of passing the company ownership to an heir is keeping the business in the family. A disadvantage is any potential family conflict if there is no clear communication before forming the plan (for example, picking one child over others to be the future owner).[7]
2. Selling the Business to a Co-Owner
Selling ownership to another co-owner of a business is another common method of BSP. Depending on what the BSP says, this could take place when the owner dies, retires, or steps back from the business.[8] Generally, the owner will determine the fair value of each ownership portion (the fair value is the share price for publicly traded companies, and the business appraisal value for privately owned businesses). Then, the owner can negotiate with the other co-owners on the price of the sale.[9] This method is advantageous because the owner is selling his ownership to a trusted co-owner; however, it can be disadvantageous because the co-owner could turn around and sell the ownership to a third party.[10]
3. Leadership Succession Planning
Leadership Succession Planning is the next common method of BSP. As described above in this article, many businesses implement internal training in their company and name a successor for different roles. This provides security in case a higher-level position becomes available; specific employees are trained and ready to step in to the role at any time. This method of BSP is advantageous because business owners can work closely in training potential successors for their role, and this method usually increases employee retention in a company.[11] The main disadvantage of this method is that it requires lots of internal procedures that many smaller businesses do not have the resources to carry out.[12]
4. Selling the Business to an Outside Party
Another common method of BSP is selling the business to an outside party. This is a good option for business owners who no longer want any ties to a business. This is usually a fairly simple method: the owner obtains a valuation of the business, and then once an interested buyer gives an offer, he can complete the sale of the company. The main advantage of this method is the profit – selling to an investor or competitor can sometimes bring in a greater profit than selling the business to a friend (or passing it down to a child). The main disadvantage of this method is that the buyer of the company may have different plans for the business that the current owner would not favor.[13]
5. Buy/Sell Agreements
Lastly, buy/sell agreements are also a common method of BSP. Buy/sell agreements are helpful in the event of an owner dying or leaving the business. The two main types of agreements are entity-purchase and cross-purchase.
Entity-purchase is an agreement between the business owners and the business itself.[14] In this agreement, the business buys life insurance policies on each owner with the business as the beneficiary. If one of the owners dies, the death benefit is used by the business to purchase the owner’s shares.[15]
Cross-purchase is an agreement between business owners where each owner holds a life insurance policy on all of the other owners. If one of the owners dies, the surviving owner(s) can use the policy’s death benefit to purchase the deceased owner’s shares from their spouse/estate.[16]
Buy/sell agreements are advantageous because they provide a definite picture of future ownership and transition. However, they can be disadvantageous in cases where there are inequalities in ownership or age between the co-owners.[17]
Conclusion
Business Succession Planning is an important part of estate planning for business owners. If you would like more information on business succession planning, contact Provident Legal Counsel today. Schedule a Consultation or call (214) 432-6100.
[1] Will Kenton, Succession Planning Basics: How It Works, Why It’s Important, Investopedia (June 2024), available at https://www.investopedia.com/terms/s/succession-planning.asp.
[2] Id.
[3] Id.
[4] Lynda Spiegel, 4 Benefits of Succession Planning, TechTarget (November 2023), available at https://www.techtarget.com/searchhrsoftware/tip/Benefits-of-succession-planning.
[5] Id.
[6] Id.
[7] A Guide to 5 Different Types of Business Succession Planning, available at https://trustandwill.com/learn/types-of-succession.
[8] Id.
[9] Id.
[10] Id.
[11] Id.
[12] Id.
[13] Id.
[14] How Buy-Sell Agreements Aid In Succession Planning, available at https://www.modernlife.com/article/buy-sell-agreements.
[15] Id.
[16] Id.
[17] See A Guide to 5 Different Types of Business Succession Planning, supra note 7.
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