For most family and closely held businesses, planning for succession is the toughest and most critical challenge they face. Yet succession planning can also be a great opportunity to maximize opportunities and create a multi-generational institution.
By Mark E. Battersby, Contributing Editor.
Everyone who has invested a great deal of time, money and energy into their convenience store business should want to see the business continue and flourish after their departure.
However, according to a recent national survey 25% of family business shareholders who are entering their senior years haven’t completed any estate or succession planning other than writing a will.
All too often, succession planning is viewed as applying only in family-owned businesses or in large conglomerates. In fact, succession planning should be a part of every convenience store chain’s strategic plan. Management must have a vision of where the business is going in the future.
The reasons for this approach are fairly obvious: If there is no succession planning process, how will the business develop and nurture its human capital? How will it assure a continuing sequence of qualified people to move up and take over when the current generation of managers and key people retire or move on? How will the business be able to plan for the future without some assurance that the key posts will be filled with people able to carry on and excel?
Basic Planning Basics
An effectively developed succession plan can provide for a smooth transition in management and ownership with a minimum of taxes. Business succession planning must also include a plan for transferring the trust, respect and goodwill that’s been built up over the years. Additionally, a business succession plan can provide financial security and freedom to the retired business owner and his or her spouse.
At its most basic, a succession plan is a documented roadmap to be followed in the event of the owner, partner or shareholder’s death, disability or retirement. This plan can include a program for distribution of business stock and other assets, debt retirement schedules, life insurance policies, buy-sell agreements between partners and heirs, division of responsibilities among successors and any other elements that affect the business or its assets.
Succession planning should also establish the value of the c-store business because, not too surprisingly, taxes loom large. The tax component of succession planning addresses the minimization of taxes upon death of the owners or principal shareholders as well as when the business is reorganized, sold or transferred.
When the Owner is the Business
Sooner or later, every c-store owner thinks about retirement. For those who own a closely-held or family business, retirement is more than just a matter of deciding not to go to work anymore. In addition to ensuring there will be enough money to retire, c-store owners, shareholders and partners must decide what will happen to the business when they are no longer in control.
An effectively developed succession plan can involve selling the business to provide a retirement nest egg or the continuation of the business with gradual changes in management control to ensure a source of retirement income, or any combination thereof.
The tax component of succession planning addresses the minimization of taxes. One of the more important aspects of business succession planning is working out the financial pitfalls following the death of the business owner. It is crucial to answer important questions up front such as, “Where will the money come from to pay taxes?” Or, if the business is a partnership, “Where will the money come from to buy out the deceased partner’s share?”
A key way to reduce estate taxes is to lower the value of the assets in the estate. These “gifting” strategies can legitimately lower any owner, partner or shareholder’s tax liability. Fortunately, making an outright gift can reduce the amount of the overall estate. Currently, property valued at up to $14,000 (in 2013) per year per donee (i.e. person gifted) may be gifted annually without any gift tax consequence.
Unfortunately, few gifting strategies directly benefit the c-store business. Other strategies for transferring the business do exist however; strategies that frequently include current ownership retaining control.
An Outright Sale
Succession planning might involve selling an owner, shareholder or partner’s interest in the c-store business outright. The time to sell is usually optional—now, at the time of the owner’s retirement, at death or anytime in between. As long as the sale is for the full fair market value (FMV) of the business, it is not subject to gift tax or estate tax. Of course a sale that occurs before the seller’s death may be subject to capital gains tax.
A buy-sell agreement, often called a “business prenup,” is a legal contract that prearranges the sale of a business interest between a seller and a willing buyer. A buy-sell agreement allows the seller to keep control of his interest until an event specified in the agreement occurs, such as the seller’s retirement, disability or death.
Other events, such as divorce, can also be included as triggering events under a buy-sell agreement.
When the triggering event occurs, the buyer is obligated to buy the interest from the seller, or the seller’s estate, at its FMV. The buyer can be a person, a group (including co-owners) or the business itself. Price and sale terms are prearranged, which eliminates the need for a fire sale if the owner, partner or major shareholder becomes ill or dies.
Selling to Current Employees
Employee Store Ownership Plans, or ESOPs, allow the owner or owners of incorporated c-store businesses to sell their interest in the business to the ESOP while deferring capital gain tax on the proceeds. Ownership can be transferred to the company’s employees over time, and the business can obtain income tax deductions for contributions to the plan.
An ESOP provides a market for the shares of owners who leave the business, a strategy for rewarding and motivating employees, as well as benefiting from available borrowing incentives, and acquiring new assets using pretax dollars.
Life insurance is a popular way to provide the cash necessary for the c-store business or the surviving owners to purchase a deceased owner’s interest, pursuant to the terms of a buy-sell agreement. Once a set dollar value has been determined, life insurance can be purchased on all of those involved in the business.
Then, in the event that a partner passes on before ending his or her relationship with the other partners, the death benefit proceeds will be used to buy out the deceased partner’s share of the business and distribute it equally among the remaining partners.
There are two basic arrangements used for this. They are known as “cross-purchase agreements” and “entity-purchase agreements.” While both ultimately serve the same purpose, they are used in different situations.
• Cross-Purchase Agreements. These agreements are structured so that each partner buys and owns a policy on each of the other partners in the business. Each partner functions as both owner and beneficiary on the same policy, with each other partner being the insured. Therefore, when one partner dies, the face value of each policy on the deceased partner is paid out to the remaining partners, who will then use the policy proceeds to buy the deceased partner’s share of the business at a previously agreed-upon price.
• Entity-Purchase Agreements. The entity-purchase arrangement is much less complicated. In this type of agreement, the c-store business itself purchases a single policy on each partner and becomes both the policy owner and beneficiary. Upon the death of any partner or owner, the business will use the policy proceeds to purchase the deceased person’s share of the business accordingly. The cost of each policy is generally deductible for the business, and the business also “eats” all costs and underwrites the equity between partners.
Successfully Planning Succession
Business succession plans usually outline in detail the who, what, when, why and how changes in ownership and management are to be executed. They also address the major issues confronting a family business owner seeking to transfer power to successors such as:
• selecting a successor;
• managing inter-generational conflict, different agendas and different goals;
• providing adequate training for the successor; and
• timing the transition.
Business owners seeking a smooth and equitable transition of their interests should seek a competent, experienced advisor to assist them in this matter. Be careful not to let tax planning control your decisions.
A tax lawyer can make compelling arguments for strategies that can minimize estate and gift taxes. A CPA can be very convincing when suggesting strategies for controlling income taxes.
No matter how talented and earnest those professional advisors are, their limited specialties should never dictate the choices for the business or the owner, shareholder or partner’s family. First determine the result desired, and then let the professionals find the most tax-efficient way to achieve that result.
Finally, succession planning isn’t something that can be done once and forgotten. To be a conscientious business leader, an owner, partner, operator, executive or manager must continually revisit the c-store’s succession plan, reviewing and updating it to reflect changes in the operation’s value and market conditions. But you must also continue to evaluate the owner, shareholder or partner’s health as well as the abilities and passion of the people it will be passed on to. As these things change, so will your business plan.