Over the next few months, we will be discussing a wide range of important business planning topics. As an attorney, I work with many business owners to provide counseling for matters of business planning and exit planning.
Here, I would like to review business continuation planning. If you intend to successfully transfer your business to the next generation, you will most likely need a business continuation plan. According to a LIMRA International study, only about 50% of businesses in the United States have a business continuation plan.
There are several key objectives in business continuation planning, as described below:
1. Preservation of the Business
A main purpose of business continuation planning is for the business to not only survive a transition to the next generation, but to thrive under new leadership. Your business continuation plan should center around this most important objective. How can you best position your business for a smooth and successful transfer of ownership when it is time for you to leave or if something should happen to you?
2. Maximization of Business Value, While Minimizing Transfer Taxes
Another key objective is to maximize how much the business is worth. A higher valuation is a key indicator that the business is healthy, which is critical for many reasons, including a successful transfer of the business to new ownership and new management. It also provides the new owners with greater options and increased flexibility, including, for example, with seeking joint ventures and new investors.
However, a higher valuation can result in higher transfer taxes. As such, a valuation of the equity interest (not just of the business itself) is critical. And appropriate discounts, such as for lack of marketability, lack of control, and built-in-capital gains, should be considered.
The two most frequently cited causes for second-generation business failure are (i) lack of a transfer plan and (ii) lack of a tax and estate plan. Effective business continuation planning can maintain a high valuation while minimizing the transfer tax liabilities. You can create a strategic transfer plan that incorporates smart tax planning and estate planning.
3. Facilitate the Ownership Transition
Next, a business continuation plan should emphasize and seek to pave the way for a smooth ownership transition. Two (2) very important transition issues are (i) transition of ownership and (ii) addressing questions of equitable treatment of family members. In particular, a goal may be for the equal treatment of family member(s) of the departing owner, for both those staying in the business and those who do not. The interests of any third-party owners should also be considered.
4. Facilitate the Management Transition
All businesses are different. Some may transition ownership with very little disruption to the day-to-day operations. The owner’s interests may be largely financial, and with the owner serving largely as a “figurehead” rather than being actively engaged in the day-to-day operations of the business. Other privately held businesses instead rely on the owner as leader of the management team (or as a key manager). No matter what the owner’s role in the company, the business continuation plan should address the effect of ownership change on employees, customers, creditors, and all matters of business operations.
In addition to these primary objectives for business continuation planning, there are many other issues to consider. Third party involvement, investors, creditors, legal disputes, corporate structure, buy-out options, and more are all on the list for planning. Further, you should periodically update your continuation plan as the business, its leadership structure, and your family interests evolve and change.
For help with all your business planning needs, including exit planning and business continuation planning, contact me today.
