If you do not have a succession plan, you are not alone. According to the 2020 Enterprise Minnesota State of Manufacturing survey, less than half of manufacturers surveyed have a succession plan. In my years of experience working with business owners, including manufacturers, many cite similar reasons for delaying succession planning. For many manufacturers and business owners, the thought of selling their life’s work and passion to a non-family member or transferring business control over to the next generation is not one they wish to entertain. Furthermore, the daily demands of operating a business means succession planning is often low on the priority list. This leads many business owners to put off formalizing a succession plan until the eleventh hour, which leaves them with fewer options than if they had started planning years in advance.
Even though succession planning conversations are understandably difficult to have, there are benefits of planning years ahead of retirement. I recently had the opportunity to work with a manufacturing company owned by two brothers who share equal partnership of the business. They were both in their 50s and plan to retire in the next 15 to 20 years. Their goal was to revisit their buy-sell agreement and evaluate how their life insurance aligned with the current valuation of the business. My team and I placed them in multiple policies that accumulate equity for a future down payment to fund the business transition to their children when the time comes to pass along the business they had built. And because we have over a decade to put their succession plan in motion, we can help them achieve multiple goals.
A succession plan is more than an exit strategy document or protection against sudden catastrophe and untimely events. Instead, it is an assurance of the continuation of your business legacy and helps maintain continuity for your customers. Simply put, a succession plan can ensure the orderly transfer of control, management and ownership of the business to the successor. And in cases when the business owner intends to sell the business, a succession plan can ensure maximum value for both the buyer and seller. In addition, a succession plan ensures you can maintain your lifestyle into retirement and continue to provide financial security for your family.
Starting the conversation
Succession planning is a complex process that involves multiple players. Often, business owners do not know who they should consult to begin the conversation. Do I need my attorney? Does my accountant need to be involved? What about my business banker or wealth advisor?
The answer is – all of the above.
You need a team of experts to craft a comprehensive and holistic succession plan that ensures not only a smooth business transition but also a smooth transition to your next chapter in life. I recommend starting with a financial or banking partner because of their high-level approach and structure to succession planning. For instance, my customers like having a central point of contact to coordinate conversations among key players such as attorneys and CPAs in the succession plan. And my team is an anchor point for our customers because of our depth and range of expertise from legal counsel to accounting and taxation.
Plan ahead to reap greater benefits
It is not just important to start the conversation. Ideally, you should start the conversation early - at least three to five years before retirement. In fact, you don’t have to be near retirement to start putting a plan in place. This is a common misconception and can be a costly mistake. There are several key benefits to plan ahead because it allows you to focus on the big picture.
Minimizing tax costs
Efficient transfer monetarily from a tax perspective to preserve and protect your personal wealth. The longer you wait to have a succession plan, the fewer options you will have. For instance, life Insurance is a commonly used tool to fund a buy-out. If you wait until just a few years before your exit, this option is obsolete as it requires a longer timeline.
A few options to minimize tax costs include a Grantor Retained Annuity Trust to transfer business assets to the children while keeping the business owner’s ability to generate income. The trust needs to be properly structured so that when the business appreciates in value, it will not be subjected to higher taxes. Others may opt for other tax saving strategies such as an Irrevocable Life Insurance Trust to mitigate taxes and create liquidity to pay estate taxes. Some business owners may create a Family Limited Partnership so that some business assets can be transferred to successors without taxation. Another common strategy is to create a Charitable Remainder Unit trust, which will allow the business owner to transfer stocks into a source of income and charitable gift. This strategy is particularly favorable if the business owners owns a sizeable portion of low basis company’s stocks. The business owner can sell the company’s stocks to earn income and name a charity as the beneficiary of the sale of some of those stocks, which will allow them to enjoy an income tax charitable deduction and increase their cash flow without a tax on capital gain.
With many different strategies available to business owners, having a succession plan years ahead of your retirement means your banking partner and wealth advisor will have more time to explore different options and recommend one that best suits your situation and vision for your business.
If your business is private, donating privately held business interests to charity can be an effective way to achieve tax savings. But strategic giving requires careful planning because there are many charitable giving strategies, each of which brings tax advantages and challenges. For instance, creating an annual gifting budget to donate directly to a charity, starting a family foundation or trust, or giving through a donor-advised fund and adding to the fund over time.
It is important to know the differences and benefits of each giving strategy and to select the right strategy to maximize tax savings. But to do so, these planning conversations need to start early. Having an early start will allow the legal transfer of your business interests to charity without negatively impacting tax benefits.
Transferring the business
The success of your business transition to the next generation or non-family member depends on strategic planning and execution. Business owners who plan to transfer control to the next generation should do so through a buy-sell agreement because of a range of benefits that protects the value of your business as well as provide liquidity for the payment of any related taxes. Overall, a buy-sell agreement makes the business a good credit risk. There are multiple steps in creating a buy-sell agreement including how the business will be valued, how business interests will be transferred to the next generation and how the agreement will be funded. Due to its complexity, it is important to weigh all your options with your wealth and banking advisor.
There are a myriad of tax and cost-saving strategies and levers your banking partner can pull to help you achieve the best possible outcome for your business and your family. But due to their complexity, planning early is critical to reap the greatest benefit.
A successful and smooth business transition typically takes a few years so the more time you have to groom a successor and to adjust your plans as your priorities change, the higher your chance of business transition success. It also allows you to transfer control over time and to implement the best possible tax-efficient business structure for your business.
Banking teams often provide free consultation to manufacturers and business owners who wish to begin succession planning conversation or to explore options. The sooner you reach out to a reputable and trusted advisor, the more levers they can pull to help protect your business legacy.