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The goal of most business succession plans is to provide for an orderly transition of management and ownership when the owner retires. Unfortunately, this goal may be defeated if the owner dies before retirement. Thus, the business succession plan should also complement estate planning measures that minimize the impact an owner’s premature death has on the transition of business ownership and management.


Many owners maintain some level of ownership until they die. In this case, the estate plan must also complete the succession plan. Therefore, planning for the ownership interest held at death often must achieve multiple goals, including minimizing estate tax, providing income for a surviving spouse, and eventually, transferring ownership in the business to the intended successors.

THE ROLE OF ESTATE PLANNING IN A SUCCESSION PLAN

Too many practitioners equate estate planning for closely held business owners with succession planning. Although there is a degree of overlap between the two practice areas, their goals are different. Succession planning strives to develop a plan that will provide for an orderly transition of the ownership and management of the business at the owner’s retirement, disability or premature death. Accordingly, it focuses on transferring ownership to family members, co-owners, key employees, or third parties and identifying capable successors to manage the business. Estate planning addresses transferring wealth to heirs, providing for survivors, and minimizing estate, gift and generation-skipping transfer taxes.


A business owner’s estate plan should be an integral component of the owner’s overall succession planning strategy. Typically, the estate plan will complement the owner’s succession plan in order to minimize the risk that they will produce conflicting results in the event the owner dies prior to retirement.


Estate planning techniques may also be used to facilitate the transfer of ownership to family members. In addition, the estate plan sometimes serves as the succession plan in those situations where the owner has no intention of retiring. 

Owner’s Exit Strategy Is a Lifetime Sale of the Business

When the goal of the succession plan is to provide for a transfer of ownership and management during the owner’s lifetime, there is always the possibility that the owner will die unexpectedly before the transfer occurs. Thus, it is important to ensure that the owner’s estate plan complements the succession plan. Otherwise, the effort spent designing and implementing the lifetime transfer strategy may be lost.


A buy-sell agreement is an effective tool to help ensure that an owner’s estate plan does not adversely affect the business succession plan. It identifies the purchaser, i.e., the ownership successor, and specifies the events that will trigger the sale of the owner’s interest in the business. In the case of a lifetime sale, the agreement generally grants the intended successor a right to purchase the business interest at a specified price when the owner retires. Assuming the owner lives to his or her retirement age, the intended successor has the opportunity to acquire the ownership interest. If the successor does not exercise the right to purchase the interest, the owner is often free to sell to a third party.


Even when the owner wants to transfer ownership during his lifetime there is always the possibility he will die prior to the intended transfer date. Thus, the buy-sell agreement should also provide for a sale at the owner’s death. Otherwise, the business will become part of the owner’s estate and will pass in accordance with the owner’s will, which may not produce the desired result.

Owner’s Exit Strategy Is to Sell the Business at Death

Many owners have no intention of selling their business before they die. Even though they will not sell the business during their lifetime, these owners should still execute a buy-sell agreement with the intended ownership successor in order to establish a ready market for the business interest at their death. This helps ensure that the owner’s estate will have adequate liquidity to pay taxes, expenses and other distributions. In addition, executing the buy-sell agreement allows the owner to negotiate the sale price when he or she has maximum leverage and avoids the risk of a “fire sale” at the owner’s death.


In the case of a buy-sell agreement that provides for the sale of the business at the owner’s death, the purchase obligation can usually be funded with proceeds from life insurance on the owner. In these cases, the owner should ensure that there is adequate insurance to fund the obligation. This is accomplished by estimating the value of the interest to be purchased and comparing it to existing insurance coverage available for the purchase. Any shortfall can be made up with the acquisition of additional coverage or a structured purchase on terms.


There are also numerous estate planning techniques that can be used to remove a portion of the business from the owner’s estate (e.g., a gifting program) or reduce its value (e.g., valuation discounts). These techniques may also be appropriate depending on the value of the business and the owner’s goals for transferring wealth and minimizing estate taxes. 

Owner’s Exit Strategy Is to Bequeath the Business at Death

When children are the designated successors, some owners may choose to transfer their ownership by bequeathing the business to the children when they die. For these owners, their estate plan will become their succession plan. There are a number of issues that must be addressed when the owner bequeaths the business to the successor.

1. Providing for the Surviving Spouse

It is not unusual for the business to comprise the bulk of an owner’s wealth. In these instances, it may be necessary to transfer the business to the surviving spouse to provide for that spouse’s support. This delays the ultimate transfer of ownership to the children and creates unique challenges that must be addressed.


If the children are already employed in the business, this structure can create tension between the spouse and the children who are active in the business, like when active and inactive children are all owners. In general, the spouse will want as much income as possible from the business while the active children may want to make smaller distributions and reinvest as much as possible in business operations. In addition, children active in the business will be able to take cash out in the form of deductible compensation, while the surviving spouse often cannot.


Another challenge is determining who will vote the stock during this period. If the business ownership is transferred outright to the spouse, the spouse will have the right to vote the shares. This can create some problems if the spouse is not competent to vote on business matters. In addition, the spouse may have competing interests with the business and vote the shares in a manner that may not be in the best interest of the business in the long-term future. If there is a concern about the spouse’s ability to vote the shares, the ownership can be transferred to a trust for the spouse’s benefit. With a trust, the trustee votes the business shares. Thus, the owner can designate a trustee who is qualified to vote on business matters.


In addition to resolving the voting issues, owners need to develop a plan that will minimize the risk that the surviving spouse will sell or dispose of the business before it is transferred to the children. If the business ownership is transferred outright to the spouse, he or she has complete ownership and is free to sell or transfer it to anyone. Again, it may be best to transfer the business interest to a trust for the spouse’s benefit. However, marital trusts must meet specific requirements if transferred property is to be eligible for the unlimited marital deduction. Generally, a marital trust must allow the spouse to dispose of the property (with a general power of appointment or through his or her estate) in order to be deductible. Again, this raises a concern that the spouse may appoint the property to someone other than the intended successor. This concern can often be overcome by using a qualified terminable interest property (QTIP) trust. However, even QTIP trusts have some drawbacks that make them inappropriate in some instances. 

2. Providing Liquidity for the Owner’s Estate

When the owner chooses to transfer the business at death, its value will be subject to estate tax in the owner’s or surviving spouse’s estate. Any resulting tax liability can create a liquidity problem for the estate if there are insufficient other assets to pay taxes and other obligations of the estate. Often, the business must be sold to pay the taxes and other expense, defeating the owner’s succession planning objectives. Even worse, the forced sale of the business may not yield true fair value for the business. Thus, it is essential to review the estate’s projected liquidity needs and develop a plan that will help ensure there will be adequate funds to meet these needs.

3. Other Estate Planning Measures

There are numerous estate planning techniques that can be used to facilitate the transfer of a business by removing a portion of the business from the owner’s estate or reducing its value. These techniques may also be appropriate depending on the value of the business and the owner’s goals for transferring wealth and minimizing estate taxes.

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