How to Avoid a Messy Succession Battle


"The very essence of leadership is that you have to have vision. You can't blow an uncertain trumpet."

Theodore Martin Hesburgh, former president of the University of Notre Dame.

In coming years, millions of Baby Boomers — those born between 1946 and 1964 — are expected to retire in the U.S. In fact, by some estimates nearly a quarter of this country's population will be aged 65-or-older within a few decades. 

Against such a backdrop, we're hearing more questions these days from business owners about how best to develop a robust succession plan. The aim of creating such a set of legal guidelines is to ensure an orderly transfer of financial control and executive responsibilities to a new generation of leaders.

"You need to take a multi-prong approach to succession planning," says Aaron Burton, an attorney at Denver-based Wade Ash Woods Hill & Farley P.C. 

On the one hand, a business owner needs to identify who possesses the skills to run a business. At the same time, Burton — whose firm is part of IFA's external network of estate planning attorneys — also recommends that those just starting to develop a succession plan take an in-depth review of who might have the best visionary and/or leadership skills to move the business forward over the longer-term. 

"A lot of times, we see succession plans dividing leadership roles — one person or group of people are put in positions to run the business, while someone else is identified in more of a senior role overseeing long-term development and planning," he says. 

In many instances, however, Burton finds that current owners pick one person to handle both roles. "There's no cookie-cutter solution," he says. "Every business and every owner is different."

Another issue to take into consideration relates to how current ownership might want to change roles and organizational hierarchies. Such changes, warns Burton, could impact the tax situations of the owner as well as key business executives. "Those who are picked to own and run a business will face different tax implications than someone who is picked to do just one or the other," he says. "It might also be wise to choose to split a division into its own company using different legal and organizational structures."

As a result, Burton urges those working on a succession plan to not only seek guidance from an experienced attorney, but also to get input from a licensed tax professional. Along these lines, while IFA doesn't provide legal advice, we do offer an in-house tax planning division. John Dahlin, a certified public accountant (CPA) who heads IFA Taxes, is available to work with our clients' outside lawyers as well as those representing other taxpayers. 

Business owners also need to keep in mind their personal estate plans when devising a succession plan, suggests Burton. "While each estate plan and succession plan is unique with its own set of distinctive legal priorities," he says,"when we see business owners pay attention to both, we generally see a much better overall result."

For example, he worked with a successful real estate entrepreneur who had started a number of different businesses during her career. Before creating a succession plan to transfer ownership of those firms to her three adult children, the businesswoman had developed a comprehensive estate plan, according to Burton. "She also took the time to educate her family and talk to them about the issues involved," he says.  

Such a level of transparency about passing her wealth to future family members complemented the later succession planning process, he notes. "After she passed away, this high level of communications and advanced planning made it much easier for her children to be involved in an orderly transition of business wealth in the most cost-effective manner as possible," says Burton. 

David Collins, an attorney at Albrecht & Barney, agrees. He encourages business owners to be proactive about estate planning and succession planning. The Irvine, Calif.-based boutique law firm is also part of IFA's outside estate planning attorney network. 

"We like to talk to business owners about how both processes should be thought of as ongoing strategies — you don't just create an estate plan or a succession plan and let it sit before the time comes when you want to retire," says Collins. "Since circumstances can change, you'll probably periodically need to review it and make sure everything is up-to-date."

When multiple owners are involved, he finds that succession planning often involves setting up rules and procedures for other owners who might want to hire friends and relatives for key positions. "There are non-death events a company's founders need to keep in mind such as what happens if an owner goes through a divorce, suffers a disability or struggles with personal bankruptcy," says Collins. "All of these situations can change the rules within a buy-sell agreement, which is the master document and playbook outlining the rules between who gets what and how a company is organized in the future."

This key part of a succession plan can be used by owners to establish rights of first refusal in the event someone wants to divest their interests, he adds. Collins also notes that some business owners prefer to include provisions giving them first crack at re-entering the business if another owner wants to exit. 

"When there are partners or other owners, you've got to plan ahead for different people leaving at different times," he says. "That means you as an owner want to be protected so that if a partner leaves, you get the right of first refusal to those shares. If you don't stipulate this upfront, then you're opening the door for someone off the street being able to come in and take control." 

Also, Collins suggests that owners consider using the succession planning process to set written guidelines for issues involving transferring of equity and/or shares of a company to family members. "Even if there is only one owner, all of your top personnel should have a clear sense of what relatives can be given stakes in the business and, if possible, how much," he says. 

These new potential owners are known as "permitted transferees." They can also include friends and other outsiders, notes Collins. "We've seen some owners tell us they're fine with giving interests in the business to not only their kids, but also long-time friends and respected members of their industry or community," he says. 

Besides putting into writing exactly who those permitted transferees are and how much equity they're allowed, Collins recommends that business owners use the succession planning process to address issues related to voting rights. "It's common for a succession plan to separate not only the future makeup of a company's ownership in terms of sharing in any profits," he says, "but also to clearly define who gets voting interests in shaping corporate policy and decision making." 

Another issue business owners need to get into the "nitty-gritty details" about as part of the succession planning process involves specifying financial terms at the time of an owner's passing or sudden exit, according to Collins. "In order to complement their existing estate plans, some owners choose to include language calling for a mandatory buy-out at the time their death," he says. "In those cases, they need to consider whether they want their beneficiaries to be cashed out or whether the financial transfer of control can take a different form."

To cover concerns that cash might not be easily raised upon an owner's death or sudden exit, Collins finds that succession plans often identify which financing options can be used to transfer interests or buy-out control of the business. "Prior to leaving a company, owners need to review things like insurance coverage — both for themselves and their businesses — and what type of promissory notes or loans might be acceptable in the future to buy-out ownership stakes," he says. 

While avoiding such a decision-making process might appeal to some younger executives, lawyers like Burton and Collins argue that procrastinating on developing a comprehensive plan-of-attack adds another layer of uncertainty to a company's ongoing success.

"It doesn't matter what size of a business you're talking about — anyone who owns a business, especially where there are multiple people involved, needs to create a succession plan sooner rather than later," says Collins. "Without it, you're raising the risk of a messy succession for the next generation of owners and employees."

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