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Monday, October 22, 2018

In Focus: Business Succession Planning

Running a closely-held business can be a rewarding experience as well as a lucrative adventure, however, a lifetime of hard work can be undermined without proper planning. One common mistake of many small business owners is failing to plan for the possibility of incapacity or the inevitability of death. If you intend for your business to survive into the next generation, it is crucial to establish a business succession plan.

Key Elements of Succession Planning

The first consideration in designing a business succession plan is selecting a successor, whether that individual will be a family member, another partner or business owner.

Regardless of who takes the reins, it is crucial for a successor to have the necessary skills, experience, as well the desire to lead the business. At times, a family member may be positioned to take over, however, often times other business partners or key people are better equipped to do so. In any event, the succession plan must clarify the rights and responsibilities of the successor, specify guidelines for operating the business, and establish a method for resolving disputes. Of course, a critical component of any business succession plan is determining the value of the business.

How to Determine the Value of a Business

Generally, there are three methods for determining business valuations -- the asset approach, the income approach, and the market approach:

Asset approach  -- A basic evaluation of a company’s value by subtracting its liabilities from its stated assets; such an analysis does not consider factors such as market conditions and good will, however.

Income approach -- An analysis of past earnings combined with a projection of future earnings which requires evaluating future cash flows and capitalization, with the goal being to determine both the present and future value of the business.

Market approach -- A more comprehensive analysis that looks to the recent sale of similar businesses in the same industry that weighs factors such as differences in the size, duration and market risk.

Transferring the Business

Depending on the exigencies of the business, a transfer can be memorialized in a cross purchase agreement or a entity purchase agreement.

  • Cross Purchase Agreement -- In this arrangement, each partner partner buys and owns an insurance policy on the others. If one partner dies, the proceeds of the policy are paid to the remaining owners which are then used to purchase the deceased partner's interest.

  • Entity Purchase Agreement -- This involves the business purchasing a single policy on each partner. Since the business is also the beneficiary, the proceeds are used buy out the deceased individual's share, which effectively raises the value of the remaining partners’ shares.

The Takeaway

In the end, it is important to remember that a closely held business is an estate asset. This is why it is crucial to your business estate taxes and creditors’ claims and ensure its continuity when you are no longer at the helm. By working with an experienced estate planning attorney, you will have peace of mind knowing that your legacy will be secure.

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