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Taking The Fear Factor Out of Succession Planning

Succession Planning

By F. John Williams III & Michael Raum
Photos courtesy of Fredrikson & Byron

For many business owners, selling or passing on a business to heirs can be as challenging as starting their beloved business was many years ago. After investing years or even decades of blood, sweat, and tears into a business, for many business owners, their work becomes a part of their DNA and as dear as a child.

We recently sat down with two local attorneys from Fredrikson & Byron law firm, Michael Raum and F. John Williams III, and got answers to a few questions they say a business owner should be considering as they prepare a continuation plan for their company.

Michael Raum: Selling Your Business to a Third Party

Succession Planning
Michael Raum is an attorney and shareholder with Fredrikson & Byron law firm in Fargo. His practice is focused on commercial law, with a specific emphasis on tax matters. He works with publicly and privately held companies on business transactions, including structuring, financing and advising on general corporate matters.

How do I identify a successor?

Michael Raum: When selling a business, you don’t always have the luxury of choosing your opportunity because a potential buyer may approach you at the time that makes sense for them.

Assuming that hasn’t happened, you should begin by identifying possible candidates. Those might include strategic targets such as others in the industry who would benefit from acquiring your company, including competitors. Other candidates include current management or employees.

If there are no clear targets or if you want to make sure you maximize your return, you may wish to retain a brokerage or other investment banking firm to help you identify targets and begin a process to obtain the best price.

When is the right time to start transitioning my business?

Raum: While some deals go quickly, it’s not unusual to take several years to identify a good target, negotiate and close a transaction.

As a result, I recommend beginning the process several years before you would like to be finished. There are always exceptions such as a situation where there’s an obvious in-house candidate to purchase. Those cases notwithstanding, however, it makes sense to give yourself enough time to do this right.

What are some business-succession techniques?

Raum: The most common technique for transitioning to a third party is simply to sell the business—either with payments over time or all of the money up front.

Whether you sell equity in the business or its assets is determined on a deal-by-deal basis, depending on factors outside the scope of this particular article. There are also some more specialized strategies for transitioning a business such as forming an employee stock ownership plan (ESOP), which can make sense for some businesses. All of these items need to be negotiated and determined as part of your process.

What issues will I need to address in my business succession plan?

Raum: In addition to all the issues outlined above, one major issue is for an owner to think about what they intend to do after the sale. Most buyers will insist that you not compete with them after the sale and will almost certainly require you to enter into a non-competition agreement.

Therefore, you should only sell if you are prepared to get out of the business for the immediate future. In addition, some buyers may want you to stay on to help transition the business, and so you should be prepared to consider whether that’s acceptable to you as part of a transaction.

What if I just die and let my family handle the business succession?

Raum: The point of a succession plan is to think these things through as far in advance as possible and seek to maximize the price you can obtain. Unfortunately, your family will not be in as good a position to maximize value as you are prior to your death. After you die, your family may not know how to keep the business running, and they may struggle to understand its value.

Also, there will not be any ability to offer ongoing services to the buyer to help maximize the price. As a result, you can reasonably expect the company to be sold for less after your death than you would be able to obtain prior to it.

F. John Williams III: Successfully Transitioning Your Business to a Family Member

Succession Planning

F. John Williams III is an attorney and shareholder with Fredrikson & Byron law firm in Fargo. He focuses on sophisticated estate planning, business succession, and trust and probate administration solutions for business owners, farmers, ranchers, executives and professionals.

How do I identify a successor?

F. John Williams III: When looking to transition a business to a family member(s), the field of candidates is often smaller and not as difficult to identify as selling to a third party.

Generally speaking, the candidate you are looking to transition the business to is already working for the business while you own it. If the person you wish to transition the business to isn’t working in the business, it is a good idea to ask the candidate to start to see if they like the business and can handle all of the challenges of ownership. If multiple family members are appropriate candidates, it will be important to see how they work together in the business before they own it together.

When is the right time to start transitioning my business?

Williams III: Like selling to a third party, the process is almost always more successful the more time that you give yourself.

Often, the gift tax or income-tax effect of a transaction that unfolds over a number of years is more beneficial to the client than a single transition event. Therefore, my clients who are planning at least three years into the future provide me with more opportunity to help them with a successful transition. However, when it comes to transitioning a family business, it’s always best to start slowly. You never want to give up ownership or control only to find two years later that you want it back—because chances are you won’t get it back.

What are some business-succession techniques?

Williams III: In a business succession to family members, there are generally two categories of techniques:

  1. Sale
  2. Gift

Often, my clients will use a combination of these two categories.

In order to accomplish either a gift or sale, I will often start by making sure the capital structure of my client’s business contains voting interests and non-voting interests. Dividing the ownership into voting and nonvoting allows my client to transition at a pace they’re comfortable with but also maintain the controlling interest until that final moment when they are ready to let go.

If the business succession involves a sale, there are trusts we can utilize to minimize the income-tax gain on the sale, and if the business succession involves a gift, we often utilize the annual gift-tax exclusion to limit the gift and estate-tax effect to the client. The annual gift-tax exclusion is the amount of gifts a donor can make to another person without causing a gift tax, and for 2017, that amount is $14,000 per recipient per year.

What issues will I need to address in my business-succession plan?

Williams III: For a business succession to a family member, you need to consider legal, tax and family issues. What I mean is that you will need to put your plan into writing, outline the terms of the plan and make sure you enforce the terms of your plan.

You will also need to talk to your attorney or tax-preparer to make sure the income or gift-tax effect of your business succession plan is one that you can handle.

And finally, you need to think about how the transition to one or more family members is going to affect the current status of your family dynamic and also the future status of the family dynamic. Unfortunately, I’ve had clients who succeeded on the legal and tax issues of a transition but wound up creating more family-dynamic issues.

What if I just die and let my family handle the business succession?

Williams III: This is a terrible idea. If you have any desire to provide stability and wealth for your family, then not having a plan in place is most certainly going to devalue the business and cause family strife.

Also, if your immediate family is not involved in the business, the stress caused by operating a business in which they have no expertise is significant. Not to mention that it opens the door for others to take advantage of them because of their lack of knowledge and understanding.

If you run a successful business, you put contingency plans in place for much of what you do. Even if you aren’t planning on transitioning your business in the near future, putting a contingency plan in place will pay off in the long run.

If you have questions about succession planning or are interested in creating one for your business, Michael Raum and F. John Williams III can be reached at:

Michael Raum
MRaum@FredLaw.com

F. John Williams III
FJWilliams@FredLaw.com

Fredrikson & Byron

FredLaw.com
51 Broadway N, Fargo
701-237-8200

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Written by Fredrikson & Byron

Fredrikson & Byron’s 277 attorneys serve clients in more than 30 practice and industry areas in seven offices in the US, China and Mexico. Fredrikson has built a reputation as the firm “where law and business meet” by bringing business acumen and entrepreneurial thinking to its work with clients, and by operating as business advisors and strategic partners as well as legal counselors.

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