Seven Steps to Strengthening Your Business Succession Plan

"business succession plan" written on sticky note

To further expand on my blog post Planning for Succession in your Business dated June 26, 2013, I have outlined the seven steps to a successful business succession plan.


Understanding family issues plays a key role in the implementation of a business succession plan.  The business owner must decide who, if any, of the family members will be involved in and potentially become leaders in the business and to what extent such family members should be rewarded differently than other family members because of their contribution of “sweat” equity to the business.  It is important to recognize that children who sit on the sidelines will often develop distrust of their siblings working for the business and will desire to be “cashed out” of the business on an equal basis to obtain their fair share of their parents’ estates.  If not properly planned for, that desire may place an unreasonable burden on the business. The business owner must also decide the extent of participation of his or her spouse, often of a second marriage, in the business, both financially and as part of management.  With an understanding of these planning issues, the owner can proceed with creating the strategic business succession plan.


The foremost planning area involves the structure of the business itself.  The business should be structured to facilitate succession planning and to minimize liquidity concerns and potential income and transfer taxes.   While an owner may believe that an ongoing business is precluded from changing its structure and ownership due to tax consequences or business considerations, this is not always the case.  A business will consider the following vehicles in formulating its preferred structure and ownership for purposes of its strategic business succession plan:

  1. Is the business structured as a limited liability company, limited partnership, S corporation or other favorable entity and how can the business be restructured, if necessary, without significant adverse tax consequences?

  2. Do the ownership interests consist of voting interests and nonvoting interests for purposes of control?  Even an S corporation can have both types of interests.  Is the business owner providing family members that are not active in the business with nonvoting interests, debt instruments, fixed assets subject to a long-term lease or other similar assets that do not provide such members with control of the business?

  3. Do the minority interest owners or the family members not active in the business have any rights of control over the other participating family members or have rights to “cash out” their ownership interests?  These rights must be documented in a shareholders agreement, operating agreement or partnership agreement to which all owners and family members are subject.  The agreement should also provide for the rights of family members to acquire ownership interests in the event of divorce, death or termination of employment and should fix a value for the interests.


The business succession plan should contain a strategic plan for the future management of the company.  The plan should identify the key employees, whether or not family members, who will contribute to the successful growth of the company as future leaders.  The business should obtain their participation in the formulation of the business succession plan and should attempt to secure the continued employment of these key leaders through employment agreements and through incentive compensation vehicles, such as stock options, bonuses, deferred compensation and partial ownership of the business entity.  The owner should take such steps as are necessary to ensure that management can continue operating the company without being required to surrender to the demands of family members unrelated to the business. The owner may also decide not to give management unfettered control of the business.  This may be especially true if management consists of certain children who would have the ability to pay themselves significant compensation to the exclusion of the remaining children. If family members were not ready for control, the business owner could designate a transition management group, through a voting trust, family trust or similar vehicle, for the period of time the owner feels is necessary for such members to mature into responsible business managers.


The family should not implement the business succession plan unless it creates a mechanism to provide the owner with financial security for his or her retirement.  This aspect of the plan should normally take on greater significance if the founder transfers control of the business during his or her lifetime.  To achieve financial security, the family should consider nonqualified retirement arrangements, such as an executive deferred compensation retirement plan, or qualified arrangements, such as pension or profit sharing plans or an ESOP.  The owner should also consider installment sales of ownership interests in the business, potentially with a self-canceling feature, and leases of real and personal property necessary to operation of the business, as additional sources of retirement income.


Liquidity issues arise both for the business itself and for the family members who are involved in the business.  Liquidity is necessary for the business to meet future contingencies and to create reserves for ongoing capital needs.  It may be necessary for either the business or the business partners to meet obligations under a buy/sell agreement.  It may also be necessary for the family of the owner at his or her death to meet estate tax obligations and after his or her death to provide additional security and liquidity for other needs.  The strategic business succession plan will incorporate planning to meet each of these objectives.  If the owner has entered into a buy-sell, operating or partnership agreement with the other business partners, they as a group should consider funding these obligations with key-man life insurance.  However, the owner must ensure that any buy-sell provisions in such agreements, which are just as important as the liquidity itself, facilitate the transition of ownership so as to prevent the disruption of the business. In deciding upon the level of additional liquidity necessary for the family, the owner should estimate the liquidity that will be available after his or her death.  This liquidity may arise from the sale of assets other than the family business or from other income-producing assets.  This liquidity may also arise from life insurance.  The family should also consider implementing an irrevocable life insurance trust (“ILIT”) or a life insurance partnership (“LIP”) as the vehicle to hold the life insurance policies for the benefit of the family.  With an ILIT or LIP, the family can shield the life insurance itself from estate taxes (and avoid paying potentially half of the insurance to Uncle Sam) to further increase the liquidity needs arising when they are needed most - the death of a loved one.  The ILIT or LIP should be an integral consideration in formulating every business succession plan.


Taxes are an important area of discussion for every business succession plan.  The family business owner must consider the federal and state income and transfer taxes applicable to the business and the family in creating and implementing the plan.  As discussed in the section below, there are several vehicles available to reduce or potentially eliminate estate taxes.


As a final stage of its business succession planning, the family should revisit its estate plan.  The estate plan should serve to compliment the objectives of the business succession plan. It should first contain the standard family and marital shares to take into account the remaining available exclusion from estate and gift tax at death.  It may also include trusts or gifts utilizing the federal generation-skipping transfer tax.  This latter planning is implemented to pass $5,000,000 of property to future generations without subjecting such property to transfer taxes in those generations. The estate plan should carry through with the business objectives of transferring ownership during life or at death in a manner that causes minimal disruption in the operation of the business.  If the transfers will take place during life, the business owner should determine the optimal manner of gifting business interests, whether outright, in trust or through a family business entity. The estate plan could also be used by the business owner to equalize, whether with business interests or other assets, the “fair” shares of the children of the owner. The family business owner should also consider more advanced planning techniques, such as a family business entity.  This is an excellent vehicle to create a structure for the selective control of assets while allowing all family members to realize income from such assets.  The owner should also consider installment sales of business interests and other assets, including sales to trusts, and grantor retained annuity trusts. Finally, if charitably inclined, a family business owner might consider the charitable remainder trust.  This vehicle is a powerful tool that has estate and income tax benefits for the grantor of the trust.  The business owner may also consider charitable lead trusts and a family private foundation to further enhance their philanthropic interests.