Succession Planning Fundamentals

A good succession plan is critical to every business because, as I was once told, a business without a succession plan is not a business, it is someones hobby.

In this article, I will offer some general thoughts on approaching these ideas and guiding a client through a succession plan.

Objectives. Prior to entering any succession planning discussion, the three most important points to cover with a client are: (i) objectives, (ii) objectives, (iii) objectives. Similar to how important “location” is to a piece of real estate, helping a client nail down his objectives at the start of a discussion is paramount.

If youve been through a number of succession planning discussions, you know the outcomes can be interesting, unique, customized, and very technical. However, despite how easy it is to “cut to the chase” and get right into a plan that you think may fit based upon your knowledge of the situation, you must force yourself to back up and start with their opinion of their objectives.

Many times, our initial impression and the plan we would have recommended are changed by opinions we later unearth from our client, their family, partners, employees, attorney, or investors/lenders. Similarly, we often are hired to “clean up” a succession plan that is deemed to be imperfect–usually, it is simply because the objectives arent met (or have changed).

Often a client will have only a partial handle on the end game they would like to achieve, and frequently they will have even less of a clear picture. In these cases, your role in pinning down the objectives and reviewing them periodically throughout the process is critical.

To help cement clients’ objectives:

–Offer them examples of the results of other succession plans that either you have worked on, or those of others that you can cite, so they can begin to “try on” different approaches.

–Whether or not they believe the end game is clear, it is instructive to begin the dialogue by engaging them in a fact-finding discussion, and then transcribe minutes from the meeting. Provide these minutes to your clients and suggest that they review them in detail, make any corrections that are appropriate, and supplement them with what their view of their objectives may be, after having read their own thoughts via the minutes of the meeting.

We often receive very positive feedback on this process–the reviewing of the notes, especially, helps clients to focus their thoughts. Giving them this kind of “homework” raises their level of interest and ownership in the task at hand.

–However you get to the objectives, commit them to writing, and use that piece as part of a mission statement which, although it will be revisable, will very much help to guide future discussions and stay on track.

Succession Plan versus Estate Plan. Dont try to solve them simultaneously, but keep one plan in mind while working on the other, and make a clear transition from one discussion to the next immediately after the first one is resolved.

By going at these plans in series rather than in parallel, you will avoid the frustration of a problem with too many moving parts. Furthermore, if you start on the business succession plan, you may find that when it is properly addressed, you will hit the ground running on the estate plan because some of the issues will already be resolved. Then, just clean up the rest.

Simplicity. We have found that the satisfaction of our clients is highest when they can understand what weve done. While very technical and sophisticated succession plans may be called for and will help to display your knowledge of the subject, it is important to end up with something that a client could explain to a friend at a cocktail party.

If they understand, theyll feel good about it. At the very least, if raising your clients comprehension level is difficult, finish the project with diagrams or a memorandum that summarizes how it will all work in the simplest terms.

Succession Plan as a Contingency Plan for an Ongoing Business. What happens if the owners die before they retire or sell their interest in the enterprise?

In the case of a sole shareholder, the key is identifying who would take over–employees, spouse, competitors, etc. Implement an agreement with those parties to purchase the entity in the event of the owners death, and, if possible, require that the purchase price be funded with life insurance, paid for by the purchasing parties.

To determine the purchase price, the agreement could state a value, outline a formula, or agree that all parties will consent to the opinions of a chosen appraiser(s) at the correct time.

If there are obstacles to this plan (e.g., the would-be buyers balk at funding the life insurance), a partnership can often be created for some other related business purpose that will have the existing owner and the would-be new owners as partners. That partnership will then agree to buy the company upon the owners death. Here, the insurance can be owned by the partnership, and it can be funded with contributions by the current owner.

With two or a few shareholders, a cross-purchase plan is simplest. Have each owner be a party to the agreement, which requires that the survivors purchase the business interest from a deceased shareholder.

Ideally, this should be funded with insurance, with each owner owning a policy on the life of each other owner. In addition to its simplicity, this type of plan has the advantage of offering a full increase in the tax basis of the purchasing shareholders.

With more complicated situations, some form of stock-redemption plan will most likely be desirable.

There, the entity will agree to buy the shares of its owners, and, again, ideally it should be funded with insurance that the entity owns and of which it is the beneficiary. Again, these plans are simple, but the calculations of value can be inflated by the increase the insurance proceeds create, and unless accounting is handled deftly, some tax basis increase can be lost in the transaction.

Timothy P. Malarkey, ASA, MAAA, CLU, ChFC, is a principal of Lee, Burke & Malarkey, LLP, an insurance advisory firm in Radnor, Penn. and a member of the M Financial Group He may be reached via e-mail at tim@lbmllp.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, February 11, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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