It can be hard to build up your own business, but it can be harder to sell it for what it’s worth. In fact, only around three in 10 family-owned businesses survive for the next generation. Whether family owned or in a partnership of non-family owners, business succession is no easy feat.
Succession Planning
It is very important to have a succession plan, even if the business is fairly new. That’s because it gives heirs a roadmap for what to do if the owner dies unexpectedly. The first step is to figure out who you want to run the business after you. If you want to pass it on to one or more family members, be sure to ask if they’d like to own it. Note that the family route may need to be considered a year or more before the transfer to ensure the successive owner has time to learn the ropes.
If you decide to sell the business to a third party, consider if you want to sell it outright or retain partial ownership and continue to get a share of the profits. Also, think about whether or not you want to participate in running the business once ownership changes hands.
Business Owner Partners
In the case of a shared business, a succession plan can help clarify the intent of both owners and provide a legal path of succession if one owner dies. In a worst-case scenario, instead of the surviving partner taking the reins to run the business on his own, he may end up having to run it alongside the deceased owner’s spouse – who might not possess the skills, experience or proclivity for the business. Or maybe the surviving spouse decides not to sell the business but receive a share of the profits without doing any work.
Key Man Insurance
If the surviving owner would simply like to buy out the deceased owner’s interest in the business, there are certain financial strategies available in the event he doesn’t have the assets to do so. One vehicle is called key man insurance, which refers to policies paid for by the business to cover the death of the business owners. Deathproceeds are specifically earmarkedto keep the business operating upon the death of the owner.
Buy-Sell Agreement with Life Insurance
A succession plan that includes a Buy-Sell Agreement contract specifies what will happen to the business shares of the owner upon his death. In most cases, the surviving business partner will use the life insurance proceeds to buy the shares at a predetermined value, whichensures that the deceased’s family are adequately paid for his share of the business upon his death.
Family-Owned Business
In the case of a family-owned business, a family member who is active in the business may take out an insurance policy on the owner and use the proceeds to buy out the interests of the non-active family members after the owner dies.
Private Annuity
Another option is a private annuity, in which the owner sells his business to his children in exchange for a fixed annuity income, based on IRS interest rates, for the rest of the owner’s life and, if elected, that of his spouse. If the owner outlives his life expectancy, the children may end up paying him more than the business is worth. However, if the owner dies sooner, they may pay less than the business is worth.
Family Limited Partnership
With a family limited partnership, the business owner transfers some or all of his business to individual family members while he is alive. When the owner dies, the portion of the business that has been transferred is no longer considered a part of the owner’s estate and is therefore not subject to estate taxes.
Seller Financing
If the owner has trouble selling the business to a third party, including perhaps a valuable employee who would like to take over, consider a seller financing agreement. Instead of paying the owner a lump sum, the buyer payshim a fixed, regular payment over a set number of years. Future business revenue secures the note, and the current owner would be qualified to know how well business revenues might hold up under the new ownership. Some sellers set up a finance agreement for just five years or so, after which time the buyer is expected to qualify to refinance with a conventional loan.It’s also possible for the financier to sell the new owner’s note if he decides down the road to get out of the financing role. The good news is that, should the buyer default on the loan, the seller would still own the company.
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