Our View from

Canal Street

Our View from

Canal Street

Succession Planning: Three Considerations and the Importance of Time

by | Aug 14, 2023 | Blog, Business Continuity & Succession Planning

A consequence of building a successful, closely-held business is the challenge of effectively planning for someone to be your successor and take over at the helm of the business. For most of our business clients, the business is akin to one’s baby. They cannot imagine stepping aside, handing over the reins, and having others lead the business forward.

Instead of thinking of succession planning as an ‘event’, think of succession planning as a process. Effective succession planning should occur gradually over time, for many reasons including human, business, and tax considerations. This article presents the top 3 considerations when putting a succession plan together that would include either turning over day-to-day management to an individual or transitioning the ownership to family members. Selling the business will be covered in another article as there are separate considerations in the plan for that option.

Tax Considerations

As CPAs, we naturally address the tax considerations first as there are both income tax and gift and estate tax consequences that are important to discuss, evaluate, and plan for. This is where time is especially important.

There are many effective tax planning strategies to begin the transfer of business ownership to family members while following IRS rules. However, it is important to keep in mind that transferring shares to a family member is presumed to be a gift in the eyes of the IRS so working with professionals to properly plan and execute the succession plan is essential to ensure the intent has the tax consequences that you expected.

The general tax strategy is to avoid taxable gifts and the associated tax liability. Allow sufficient time – a minimum of 10 years is a good starting point – for effective succession planning and tax planning. For example, gifts could be spread out over many years so as not to trigger capital gains taxes. Lifetime uniform gift and estate tax exemptions offer effective strategies to gift ownership in the business over time, taking advantage of your lifetime exemption.

Human Considerations

As accountants, we are numbers people, but the reality is when it comes to succession planning of a closely held business, the human element is paramount. For the business owner, there is (rightfully so) a lot of blood, sweat, and tears associated with building a successful business.  The journey has deep meaning and many memories as do the staff and loyal employees who have been big contributors to where the business is today. In addition to these human emotions, then we add to the mix, family relationships, perhaps multiple generations and their respective roles and interests in the business. This is where planning for a successor and transferring interest in the business can become a hornet’s nest.

We often find that planning the succession of a closely held business is a taboo topic. It is not discussed openly which further fuels the emotions associated with the topic. Again, time can be your friend. We suggest you discuss the reality of the need to have a successor to carry on the business and run the business. With open conversations well in advance of the need to have a plan in place, the topic will be less overwhelming and emotionally charged as you and family members talk casually about the need to talk about it and start thinking about a plan well in advance of needing to implement one.

We recommend that you begin these conversations well in advance of the ten-year minimum to begin the process. As your children get older, it can be part of ongoing conversation that you will at some point identify a successor and work with that individual(s) to have defined roles to carry on leading the business.

Exposing the next generation to the business is recommended. This can be done over the years; once they are college age you can make connections between their course work and the business. As they identify interests and launch their careers, discussing business can be a useful way to assess their interest level and link their individual interests to opportunities in the business. When there is clear interest, exposing them to a variety of aspects of the business including introducing them to management roles is important.

Human considerations are significant as a business owner plans for the future of the business and has family relationships to protect and maintain. Many owners worry about showing favoritism or alienating family members as they consider the human element of developing a succession plan and revising it over time.

Business Considerations

Business considerations are often more top of mind for the owner. As an entrepreneur, you are naturally thinking about who has the right skill set, interests, and passion to be your successor. Many business owners confide in us during the succession planning process that they are not ready to give up control. They do not have clear, logical choices that will best serve the business, the clients or customers and the employees. They have real concerns about making a decision that is bad for the business.

What do you do?

As referenced above, this is where we can develop a plan with you to maintain control of the business while devising a smart and phased plan to create minority interests. This protects the business and addresses your initial concerns should the kids be too young or lack the skills to step into leadership roles.

A suggestion to avoid thinking of succession planning as one successor is to think about a colonial house with multiple rooms and each room has a different key. There was a great article about this concept years ago in Harvard Business Review (“Making Better Decisions in Your Family Business”) to explain the importance of defining roles and interests in a closely held business, so they are compartmentalized like rooms in a home. In developing your succession plan, we can apply the same thinking to identify passive owners (e.g., perhaps one or more of your children who have no interest in working in the business). Then active owners, who may include a brother or sister working in the business with you today, but their roles are defined and distinct from yours as leading the business. This concept is a way to think about the business, your primary interests in the business remaining viable and successful while identifying family members and roles whether active or passive that become integrated into the succession plan. Together with your other trusted business advisors, we can discuss the roles and review and revise over time.

The Importance of Time

You want time on your side as you undertake what may feel like an ominous project. The more runway you have to consider your options, evaluate tax consequences, think through family and human considerations, and evaluate candidates and roles to best support the continuity of the business, the better you and the business will be.

Your business and its associated real estate are typically your biggest asset. Start the discussions well in advance of when you may want the plan to be implemented. Starting well in advance will give you more flexibility. Advance planning also enables us to assist you in defining and evaluating options and having multiple, in-depth discussions over time as factors change, tax laws change, and your children grow up.  Time will also assist you with one of the biggest challenges for any business owner: preparing and practicing the art of detaching from the business.

At LCW CPAs, we offer business continuity and succession planning services to our business clients as a logical way to help you achieve both your business and personal goals. Our commitment is to support you every step of the way; being a sounding board, providing an objective perspective and sharing insight and experience to ultimately have you achieve the peace of mind that the three primary considerations: tax, human, and the business are all well incorporated into your succession plan.

Are you nearing ten years from when you want to implement your succession plan?

If so, call us or contact us. We can help you look ahead with confidence.