Estate Planning

Motivating the Business Owner
to do Succession Planning

by David K. Smucker, CPA, CLU, ChFC

This article will give you several provocative and sometimes disturbing questions to ask your clients about the pitfalls they would encounter if they didn’t have a succession plan. The mechanics of business succession planning are relatively simple – not simple, but relatively simple. The biggest challenge can be getting the business owner to start the planning process.

The goal of succession planning is the orderly succession of ownership and management of a business. It’s always necessary to discuss financial products during the succession-planning process. For example, life insurance is needed to fund buy/sell agreements and provide additional capital transition to new ownership. Life insurance, annuities, and other financial products can be used to fund qualified retirement plans and personally owned savings and accumulation programs. Here are some important questions to ask your clients:

Have you set your retirement date?

This provocative question could get any number of answers, but the goal is to start the thinking process. It can involve succession planning, qualified plans, life insurance as a cash value accumulator, annuities, etc.

Have you begun saving for retirement? How much money have you put aside for retirement? What would you use to generate income in retirement?

The business represents a substantial portion of most business owners’ net worth; it could account for most of the business owner’s net worth. It’s quite possible that they would have to sell the business to pay for their retirement. It becomes a double problem when the business owners have to finance the sale. A buyer who can’t pay the entire purchase price would have to pay the owner in installments over a period of years. Having to bear that risk would jeopardize the owner’s retirement. If the business falls on hard times, owner may have to repossess the business and try to get it back on its feet.
One answer is a buy/sell agreement. Another is the establishment of a qualified retirement plan, life insurance as a source of cash to supplement retirement income, or the purchase of annuities or other investment products. It’s also possible that the answer could encompass all of these.

How would you transfer the business to a child who is active in the business and wants to take it over?

There could be a gift or estate tax liability with a transfer that is done by gift or inheritance. If the transfer is by inheritance, the business may have to be sold to pay the estate tax. Careful planning with an irrevocable life insurance trust could provide the liquidity to pay the estate taxes and preserve the business for the next generation.

One of more of your children is active in the business and wants to take it over. But what about the ones who aren’t involved? How would you provide for them?

If you gave the business only to the children who are active in it, you might be starting a family fight that would last far into the future. A buy/sell agreement could be used to sell the business to the active child. It could be funded with life insurance on the owner.
This often requires an installment sale to sell the business to a child upon the owner’s retirement. Few businesses generate enough cash for a lump sum purchase. The sale could also lead to the purchase of life insurance on the child who is buying the business with a collateral assignment in favor of the selling parent. This would secure the installment sale obligation. It could also lead to an estate equalization sale with life insurance on the parents so the inactive children inherit the cash from the policy benefit while the active child inherits the business.

Do you want to go into business with your partner’s spouse? Do you want to force your spouse to go into business with your partners and vice versa?

The answer to these questions is frequently “No.” That leads to additional questions about life insurance funding for of a buy/sell agreement. Even if the answer was yes, you could ask whether a buy/sell agreement is in place.

If you were to die, would your partners be fair to your spouse? Would they try to buy your share of the business at a discounted price?

It would be most appropriate to ask this difficult when there are several co-owners. The point is that a buy/sell agreement with an accurate valuation and adequate insurance coverage, protect each owner’s surviving spouse, making sure a fair price is paid for the business upon death or retirement.

How is your estate plan set up? Are you leaving the business to your spouse? Does that make sense?

Many spouses do not take an active role in the business. Leaving the business to the surviving spouse, who is unable to run it, could cause the business to fail. The couple could plan for the business to close. A simple personally owned life insurance policy on the business owner would give the surviving spouse the capital to support themselves in retirement.

Are there unstable marriages among partners, children who are active in the business, or key employees to whom you might want to sell the business?

This difficult question needs to be asked. A divorce could put the business in jeopardy. The buy/sell agreement may need to be modified to allow for these potential challenges.

How long has it been since your buy/sell agreement was reviewed?

Buy/Sell agreements need to be reviewed and updated as necessary; an annual review is an excellent idea. Buy/sell agreements are sometimes negotiated and forgotten. A Buy/sell agreement is designed to take care of the situation, as it exists today. That means it’s almost certain that provisions would become outdated in relatively few years.

Is your buy/sell agreement funded with life insurance? Has the insurance been reviewed recently?

The CSO 2001 mortality tables were recently incorporated in all life insurance products. The policies should be reviewed to see if the coverage is adequate. Life insurance needs may have changed. Term coverage may have been adequate in the past, but permanent coverage could be called for now.

Is the business valuation in your buy/sell agreement up to date?

The value of the business becomes outdated as it grows or contracts. If the business valuation is not up-to-date, the surviving spouse could be forced to take a low value when a much higher value one is appropriate. On the other hand, if the business has slowed and the stated value is too high, the business could end due to an unrealistically high price. The valuation needs to be reviewed annually. Formula valuations are often incorporated, so the valuation is self-adjusting. But even the formulas need to be reviewed to make sure they would still produce an accurate valuation.

Many of your customers depend on you. If something happened to you, would the business continue to serve them?

Succession planning can give customers some assurance that, in the event of the owner’s death or retirement, the business would continue to provide value, products, and services to its customers.

Do your lender bonding company, employees, and suppliers know you gave a succession plan?

Everybody who does business with your client needs to know if there’s a succession plan in place. Closely held businesses (not publicly traded on the stock exchanges) are inherently risky because they are so dependent on their owners’ participation. So, anyone who does business with them needs to know that. In case something happens to the current owners, provisions are in place for an orderly transition of ownership and management. Knowing this reduces the risk of doing business with the closely held business. It also could reduce the interest rate on a loan and help the business get a better bonding capacity and better payment terms from a supplier. It could encourage certain customers to stay customers.

Your employees depend on you for their income and they may want to make your business their career. Would the business continue to provide those incomes and careers if something happened to you?

This appeals to the business owner’s sense of stewardship and their obligation to provide continuing employment to the employees if the owner were to die or retire.

Someday you’re going to be out of the picture, one way or another. Have you made provisions for that change of ownership?

You should do it now while you’re in a good position to see to the arrangements. This simply points out that the owner is in the best position to arrange for the succession of ownership and management. Tomorrow could bring injury, disability, or death. Don’t put off to tomorrow what you can do today.

Your business has become a major presence in the community and a lot would be lost if its doors were closed. Have you taken steps to make sure the business would continue after your retirement or death?

This question appeals to the owner’s sense of stewardship as well as their ego. Many business owners see their businesses as a monument to their efforts, an expression of their personality and values, and a culmination of a lifetime of work. It’s shocking for them to think that the business would close in the event of their disability or death. A succession plan can give them some assurance that the business would have a chance to survive into the next generation.

Would any key employees be interested in buying the business in the event of your death or retirement?

Answers to this question could offer a solution to the business owner and a way to retain key employees. Key employees may see themselves as future owners of the business or future competitors with the knowledge and experience they’ve gained while working for the business. An owner’s willingness to consider selling to them can keep that expertise in-house, help the business grow, and provide the team that would buy the business when the owner retires. That educated and experienced team of key employees could be the ideal group to take over. The buy/sell agreement is the tangible proof that they are next in line for ownership and they would have their chance to take the business to the next level.

Is the business worth enough for a aale to finance your retirement?

For some businesses the answer would be “No, it isn’t valuable enough” That’s bad news, but it could be good news, too. Realizing its truth could prompt the owner to redouble efforts to save for retirement, which life insurance products can facilitate. It could also prompt the owner to work harder at making the business more profitable and more saleable.

You say you’re going to hold onto the business until you die and then leave it to someone. Have you made provisions for that in your wills and trusts? Who is going to get the business? Would there be estate tax? Would the recipient have the capital to see the business through the transition? Would your surviving spouse have enough to live on without the income that you bring home from the business?

These cautionary questions should prompt a re-examination of the owner’s succession planning, saving strategy, and life insurance policies.

What is your plan for the business? Do you see it continuing after your death or retirement or do you see it closing?

A succession plan would need to be in place, funded with life insurance, to provide the cash to the buyer if it is to be sold or possibly to provide liquidity for estate taxes if it’s bequeathed to someone other than the surviving spouse.

In Conclusion

These are only some of the questions that will motivate clients to do succession planning.
What is critical is for you to be genuinely interested in your client’s well being.
One final note; never, never, never leave it to the business owner to complete a business succession planning fact finder. Help the business owner complete the form. Without your involvement, sincerity, and empathy, the fact finder is nothing more than another form that needs to be completed when there’s enough time and we all know there would never be enough time. q
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David K. Smucker, CPA, CFP®, CLU, ChFC, is a Director in Advanced Sales for Nationwide Financial Services, Inc. in Columbus, OH. He can be reached at dsmucker@nationwide.com. Federal tax laws are complex and subject to change. Neither Nationwide nor its representatives give legal or tax advice. It would be important to talk with an attorney or tax advisor for answers to specific questions.