Types of Business Succession Plans
In short, there are two basic types of business succession plans.
One is to sell either your share in a partnership or LLC, or your entire family business or sole proprietorship. You can simply sell your personally owned business before you retire, or have a plan in place to sell it if you become disabled. In a partnership or LLC, you can utilize a buy-sell agreement.
The other kind of plan is to pass your business or partnership share along to others. In a family business, you can simply leave the business to your heirs and designate someone to run it in your stead. If you’re involved in a partnership, you can transfer your share into a living trust and name a beneficiary. To do so in an LLC, you will have to get the agreement of the other members.
The Benefits of Business Succession Planning
The obvious benefit of having a business succession plan in place is to prevent your business from becoming chaotic should you suddenly be unable to continue your role there. Your family may be ill-prepared to take over, or your partners may argue over what to do next.
Another consideration—a major one—is the value of the business. If you die and leave your business to your family with no sales plan in place, they will have to get it assessed and valued and then find a broker to sell it for them.
The same goes with a partnership structure, or a Limited Liability Company (LLP). Unless you and your partners have an agreement in place about how your share is to be bought out or transferred, confusion can reign. Fortunately, most partnership agreements and LLCs have transfer clauses in place.
One transfer option is a simple buy-sell agreement, which can be exercised while you’re still alive— for instance, when retiring. A set value for your share and the shares of others can be written into the partnership or LLC agreement, or a mechanism for valuation can be set in place. Otherwise, if one partner suddenly dies, there must be a transfer agreement in place.
The majority of these transfer agreements include the purchase of life insurance on each of the partners. These arrangements are either “cross-purchase agreements” or “entity-purchase agreements.”
In cross-purchase agreements, each partner buys life insurance on the other partners and is both the owner and beneficiary of the policy. The surviving partners then use the proceeds to buy out the deceased partner.
In an entity-purchase agreement, the business itself purchases one policy on all the partners. When one dies, the proceeds are used to buy out the deceased partner.
Picking a Successor
Unless there’s an outright sale to an outside party, picking a successor to run a business is also an important part of business succession planning. The successor to best manage a business may not always be a family member. In a partnership, another partner may simply step into the role, or the partners may agree in advance on a succession plan and hire someone from outside their ranks to run everything.
The bottom line: you’ll need to have someone on board and train them in advance to take over management, whether it’s a family member or trusted employee. Making sure there is a competent successor to run a business is an important part of succession planning—unless the plan is simply to sell your family business or your share to your partners.