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Succession Planning for Business Owners

Throughout the years, you have diligently cultivated your business, shaping it according to your aspirations, dreams, and vision. But eventually, the time will come to pass the keys on to someone else.

Your decision on how to transition your business will be one of the most significant choices in your long entrepreneurial journey, with significant implications for not only your retirement but the future of your loved ones and loyal employees. So, it goes without saying that its succession should be carefully planned and executed.

This article outlines some of your succession options as a business owner.

Selling Your Business

This may seem like an easy choice – sell your business for a hefty sum of cash, move to Costa Rica (if Florida isn’t sunny enough for you), and live the retirement dream life. And maybe that really is the best move. But there are other things to consider first, such as how to receive your earnings.

While receiving a lump sum can be appealing, how will it impact your tax situation? A large infusion of cash can wreak havoc on your tax situation for years to come, pushing you into a higher tax bracket and increase your Medicare premiums.

On the other hand, a series of payments might offer a more tax-efficient way to manage your finances post-retirement. Plus, it can help with your post-retirement budgeting, knowing exactly how much you’ll receive and when.

You should also consider what you would like to do with the profits from your sale. You can use your profits to purchase investments or other financial products, such as an annuity or insurance, or perhaps another business that provides passive income.

Also, be sure to conduct a careful valuation of your business and its assets well before you put it up for sale. A detailed classification of each asset can help you keep your tax bill low when you do make the sale.

Beyond the financial implications, it’s essential to find a new owner who would carry out your legacy in a befitting manner, one that will continue to inspire your employees and keep your loyal customers happy.

Also, keep in mind your timeline. Even if you’re not quite ready for retirement, you may want to look into selling while your business is in its prime. You never know what’s around the corner – your business may begin to experience complications at the wrong time, i.e. right when you buy your tickets to that retirement dreamland.

Consider a Merger

It’s not easy to just walk away from a business. If you think you’ll find it difficult to just let go, perhaps a merger should be in the cards. Staying involved in your business for a few extra years may help provide the closure you need while you help steer it down the right path before saying that final goodbye.

With a merger, you may even be able to build something even better, increasing its valuation, ultimately netting you a greater profit when you finally do exit. Your company will suddenly have access to new talent, a more extensive customer base, and perhaps even more capital.

You also get the chance to lead the transition of your employees and costumes. People often prefer a face they know, one they’ve worked with for years, one they can trust.

However, a merger comes with unique risks. There may not be room for all of your existing employees, or the new team members may come into conflict with each other. Alternatively, your existing customers may not be pleased with any new systems put into place and seek business elsewhere.

Also, a merger can take a long time, especially if you face significant legal challenges and regulatory red tape. In the worst-case scenario, the merger may even be unsuccessful, leaving you with regret and wishing you’d just sold it while you could.

That’s why it’s vital to seek out a merger with a firm that shares a similar vision, values, and goals with an owner who is easy to work with. Culture is key, and opposing company cultures can be a recipe for disaster. 

Employee Stock Option Plan

Providing your employees with a strong incentive for the company to succeed can be a potential boon to your exit strategy. An Employee Stock Purchase Plan lets you maintain control over your business as you transition into retirement in a potentially tax-efficient way. By executing sales of your interests to the ESOP over time, you can time the sales to fit within your tax plan and liquidity needs. Depending on the corporate structure, you may also realize specific tax benefits.

C-Corporations: You can indefinitely defer the taxes otherwise owed on proceeds gained by shares sold to an ESOP in a C-Corporation via a 1042 exchange. Basically, you sell your shares to the ESOP and then reinvest the proceeds into qualified replacement property,’ such as common and preferred stock, convertible bonds, and corporate notes.

Assets that are not qualified replacement property include ETFs, bank CDs, mutual funds, municipal bonds, REITs, and government bonds, among others.

If you were planning to reinvest the proceeds of your sale in any case, then a 1042 exchange may make even more sense. If your company is not already a corporation and you’re considering an ESOP, remember that to execute a 1042 exchange, you must have held the shares for at least three years. Also, at least 30% of the shares must be sold to the ESOP. You can’t sell only 10% and execute a 1042 exchange.

S-Corporations: The tax benefits obtained via the sale of shares of an S-Corporation to an ESOP are less direct or obvious than those of a C-Corporation. When an ESOP owns S-Corporation shares, the percentage of its interest in the corporation isn’t subject to federal income tax. Let’s imagine that an ESOP owns 50% of an S-Corporation. That means 50% of the corporation’s income isn’t subject to federal income tax. This means that more funds are available to the corporation as a whole, which can be used to expand operations, pay more distributions, reinvest, or for other purposes.

Early planning for internal succession is critical. By pinpointing future leaders ahead of time, you can train them properly, ensuring that when it’s time to step back, your firm remains solid and well-led. Plus, gradually introducing your hand-picked successors to your clients can help smooth the transition.

Family Succession

For many business owners, the possibility of passing a business on to a son, daughter, or grandchild is the ideal route. Besides passing on the business to someone you can trust, you get to help ensure your family’s financial success for possibly generations to come. You also get the added benefit of doing so in a tax-efficient manner via a combination of trusts, gifting strategies, and a family-friendly business structure, such as a Family Limited Partnership.

Other Succession Planning Considerations

Unfortunately, not all business owners will get to experience a long and fruitful retirement due to early death, illness, or accidents. We tend to focus on the best possible scenarios in succession planning; however, it’s crucial to be prepared for the worst.

This case underscores the importance of a holistic financial plan that grows your wealth and navigates taxes through every life stage. Ready to unlock the potential of your financial future? Click below to schedule a meeting with Walters Strategic Advisors, where we blend financial expertise with tax acumen to guide you towards a tax-efficient retirement.

Life Insurance

Insurance serves as a safety net, ensuring that your loved ones are financially protected in the unfortunate event of your passing. It can offer a lump-sum payment that can be useful in managing mortgage costs, replacing lost income, or simply providing a financial cushion during a period of transition and grief. It can also be structured in a manner to pass on generational wealth in a tax-efficient manner as part of a broader estate planning strategy.

The Importance of a Will

Crafting a written will is another critical component of succession planning. By clearly naming executors and outlining the distribution of your assets, a will eliminates ambiguity and ensures your wishes are fulfilled. It’s also useful in preventing the default application of laws, which might lead to protracted legal proceedings and unintended asset distribution.

In Conclusion

Whether selling your business, passing it on to the next generation, executing a merger, or setting up an Employee Stock Option Plan, each succession path offers unique advantages and drawbacks. The key to a successful transition is not only understanding the financial implications but also ensuring that the legacy and culture of the business you’ve spent decades cultivating are preserved.

Are you ready to start succession planning for your business? Walters Strategic Advisors are here to help guide you through each step of the process. Contact us today to schedule a meeting and secure the legacy you’ve worked so hard to build.

For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Certain information is based on third-party data and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. The scenario mentioned in this presentation is not an actual client experience. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this presentation.

About the Authors

  • Douglas Walters

    Doug is the Managing Partner of Walters Strategic Partners, LLC, a licensed Registered Investment Advisory firm. Doug is a licensed Certified Public Accountant (CPA) in the state of Florida and holds a Series 65 Investment Advisor Representative securities license. He is also a member of the AICPA. With over 28 years of experience as a CPA, he believes investment decisions should be based on decades of peer-reviewed research rather than relying on the latest “hot tip” from media outlets. This empirical evidence puts the science of investing to work for his clients.

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  • Jose Joia

    Jose M. Joia is a Wealth Advisor at Walters Strategic Advisors, LLC. As a member of the team, Jose’s responsibilities involve comprehensive wealth management, planning and customer service. He has over 6 years of industry experience specializing in planning and solving unique issues his clients encounter. Jose has experience serving individual clients, business owners and non-profit organizations.

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