The transition of a company to its successor owners must be planned for in advance and properly executed to be successful. Unfortunately, the vast majority of company owners delay planning for such succession or completely fail to do so. Owners should begin planning while they are still healthy and active in their companies. In family companies, only approximately thirty percent (30%) succeed into the second generation and only approximately fifteen percent (15%) survive into the third generation. A succession plan is essential to the continuation of the company, no matter what the company's structure or size.
There are a number of succession methods to implement an orderly transfer of the ownership of the company. Some common succession methods are:
A succession method most appropriate to closely-held companies is the buy-sell agreement. Inc. magazine calls buy-sell agreements "the next best thing to immortality." Buy-sell agreements protect the company against unexpected events such as an owner becoming disabled, dying, desiring to sell to a third party non-owner, retiring, becoming divorced or bankrupt, or terminating his or her employment with the company.
A succession method commonly used in family companies is a family limited partnership. It is often used by parents and grandparents as a vehicle to transfer ownership during their lifetimes while retaining control and management of the company.
Because stock in a Subchapter "S" corporation cannot be held in a family limited partnership, the recapitalization of the family business that is in a Subchapter "S" corporation can be used to achieve the same results and benefits of a family limited partnership.
Owners of companies can make gifts of ownership interests to the next generation. However, gifting should be done in a careful manner. Before gifting company ownership, control restrictive agreement and many other issues need to be addressed.
Another possible succession method is via testamentary transfers. However, large testamentary transfers may be subject to federal estate tax. The most common method of testamentary transfers is through the establishment by the company owner of a revocable living trust during the owner's lifetime. One of the primary reasons to establish a revocable living trust is to avoid the expense and delay of probate of the owner's estate, but such a trust can also be utilized for company succession purposes. The terms of the trust can pass the right to ownership of the company to one or more beneficiaries in various ways, some of which are:
Proper business continuation and succession planning is essential for any company. Failure to plan for orderly company succession can be catastrophic, resulting in not only monetary losses, but even the loss of the company itself. Proper planning will increase the chances of the survival and smooth continuation of the company, and avoid disputes and possible litigation among the surviving owners, family members and key employees.