Spoiler alert: In the acclaimed HBO series “Succession,” the patriarch of a family run business, Logan Roy, fails to name a clear successor. After his sudden death, the family is ripped apart. Eventually the business is sold to outsiders under dire conditions.
Don’t think that your family is immune from a comparable problem. If you fail to develop a succession plan for your small business, it could cause intrafamily conflicts, especially if one or more family members are already involved in the business. Unfortunately, this may lead to financial chaos for the business and even its ultimate demise.
Conversely, with a succession plan in place, you can pave the way for a smooth transfer of leadership when you retire. It can maximize current estate tax rules with the flexibility to adapt to any future tax law changes. And the plan can also provide contingencies if you die or are disabled before retirement.
Succession planning in a nutshell
The primary goal of succession planning is to structure leadership within a company upon the occurrence of a specific event. Thus, the business can continue to operate without any major hitches, even if the founder or long-term president abruptly retires or passes away. It can also use life insurance or some other source of liquidity to keep the business humming.
When you anoint a successor to take over the reins — be it a family member or a valued employee — you ensure that there won’t be a vacuum at the top for any appreciable length of time. This provides a road map for the continuation of the business. It effectively reduces expenses, enables the business to function with minor disruption and maintains the qualities that have been instrumental in its success.
What’s included in the process? As the business owner, you should identify the critical positions requiring successors. Develop a profile of each position and the expectations for future growth. Analyze the top candidates and choose the best ones. Then create a structure preparing them for the transition, including education, training and communication of information.
The plan generally incorporates documents and contractual obligations to facilitate the transfer of power. This begins with your will and any trusts established to benefit family members. It also often includes provisions to distribute stock and other assets, life insurance and disability insurance policies, buy-sell agreements, and special instructions.
Be mindful that this isn’t a one-and-done process. The plan will evolve over time and should be modified to reflect major changes. Make sure the plan is flexible enough to accommodate this.
Estate planning considerations
A succession plan is just one component of a business owner’s estate plan. Coordinate it with other estate planning strategies.
The federal gift and estate tax exemption amount is $13.61 million in 2024. Although this generous exemption covers most estates, it’s scheduled to decrease to $5 million (indexed for inflation) after 2025. In addition, there may be state tax complications. Under the annual gift tax exclusion, you can give up to $18,000 in 2024 to each family member (doubled to $36,000 for joint gifts by a married couple).
It’s important to establish the fair market value (FMV) of your business. The FMV is generally defined as the amount a typical buyer would be willing to pay in an arm’s-length negotiation. It can be incorporated in a buy-sell agreement created by an experienced valuation professional. (See “Supreme Court adds to business valuations” below).
Don’t just present your succession plan to family members and employees. Have frank discussions when warranted (for example, if one sibling is chosen over another). Be sensitive to their feelings. Listen with an open mind to the feedback they provide.
Finally, be careful to avoid two common mistakes of small business owners. First, give yourself enough time to complete the process. Don’t wait until retirement is just a year or so away. You may have to work through several scenarios before you find the right fit. And, even if you’re in the pink of health right now, that doesn’t mean it will last.
Second, expect the unexpected. It’s not unusual for your top choice for a position to decline it, be unable to fulfill the duties or leave the company altogether. Have contingencies built into the plan. Think two, three, even four steps ahead.
Putting it all together
Creating a succession plan can be an arduous process. Fortunately, you don’t have to go it alone. Rely on your professional advisors for assistance.
Sidebar: Supreme Court ruling addresses buy-sell agreements
In a significant new case, the U.S. Supreme Court increased the value of a business for federal estate tax purposes (Connelly v. United States, No. 23-146, June 6, 2024, Supreme Ct.). The nation’s top court addressed the ramifications of using corporate-owned life insurance (COLI).
Key facts: Two brothers, co-owners of a building supply company, entered into a buy-sell agreement. When one brother died, the survivor declined to purchase his business interest, so the company paid the tab with $3 million in COLI proceeds. The court ruled that the $3 million must be added to the value of the deceased brother’s interest.
Keep this ruling in mind for the future. You may want to modify buy-sell arrangements accordingly.
