Passing the Baton

May 1, 2005

After years of building up your business, you are faced with the ultimate question: how to pass on the business to the next generation? The “next generation” may be one or more of your kids who have learned the family business; it may be one or more employees you have brought along, and don’t want to lose. Let’s take the question a step further: how can you arrange to transfer some, and eventually all, control, while keeping an economic interest in the business as you prepare to retire?

The usual response is to put off dealing with succession issues. There are always plenty of reasons to wait. For example:

  • It costs money (but not nearly as much as seeing that key employee become impatient and go into business for himself).
  • It may be uncomfortable making choices as to how to treat multiple kids and/or employees (don’t fool yourself: they’ve already figured out the question; giving them the answer will clear the air).
  • You may be worried that your preferred successor didn’t make the best marriage, and that the business might get tangled up in an eventual divorce.
  • You may feel that waiting a little longer will give your successor a chance to get his act together (this hasn’t worked for Queen Elizabeth; best to deal with the Prince Charles you’ve got, and consider putting the business into trust for Prince William).

When the question comes up, the better answer is to pull together your team, including your lawyer and your financial adviser, and start planning. Everyone (including you) will be glad to know where things are going.

There are an infinite number of ways to structure succession. You can place your business in an entity (LLC, partnership, trust). This allows you to keep on working, if you wish, but with an agreement to transfer management and some ownership as time goes on, while you retain rights to income. You can continue to own an interest in the business as your work schedule decreases, and take your money out that way. You can lease or lend assets to the company so that your successors can use cash flow to gradually buy you out.

As you get into the process, you will probably find that it ties together a lot of questions you may have been planning on dealing with “someday”, or even “soon”. Succession planning is a great opportunity to tie into your estate planning process, and into figuring out your insurance needs.

For some companies, more sophisticated, tax-driven methods may be appropriate. You may have heard about ESOPs, for example – employee stock ownership plans. These allow the owner of company stock to sell some or all of the company stock to a trust for qualified employees. Stock is transferred as the trust pays for it. Because the government wants to encourage ESOPs, there are some big tax advantages. ESOPs are not just for huge corporations. Your team can determine whether this, or any other, option makes business sense for you.

For others, a simple partnership will do. But even then, you want to make sure that your rights are protected, and that you will minimize the tax bite from your process. Your team can help.

Your lawyer, and your financial planner, can only work for you in this process. A good lawyer will suggest that your successor should have independent advice before entering into an important agreement with you. This may seem like a waste of time and money, but a second set of eyes, looking from a different position, is likely to see more.

As you proceed with succession planning, you are likely to see at least one big benefit. The future will matter more to your successors. Your business will start changing from “my company” to “our company”. Structuring your succession around your own individual needs and characteristics, and those of your successors, can give you an excellent chance of greater success than you could ever have going it alone. Don’t put it off – talk to your team!