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Keys to Ownership Transition and Business Succession Planning


Business succession planning is essential for all privately-owned companies and the importance of a detailed plan is magnified during periods of economic upheaval.  Planning for ownership transition is even more critical for companies that may also rely on future owners to be key members of management and possibly rainmakers who generate sales.   As a result, it is vital that closely-held businesses have a robust ownership succession plan that is updated on a regular basis.  Following are five key steps to effectively transition ownership.

Understand Your Goals for Ownership Transition

One of my favorite Yogi Berra quotes is “If you don’t know where you’re going, you’ll end up someplace else.”  Unfortunately, this often applies to ownership transition as many companies just move along with no particular destination in mind.  It is critical that the most important goals are defined if you even hope to get there.  Things certainly won’t happen exactly as planned but if you can outline your goals and see if a plan can work on paper, then there is hope for it to work in the real world.

One of the biggest questions to answer is whether it will be an internal or external ownership transition.  Most companies look first at an internal plan as it provides for a continuation of the
business, access to a pool of buyers who are in the company, and ongoing control until retirement.  While an external sale might provide for a higher price and greater liquidity, business owners will most often look at an external sale only after an internal transition fails or when they are approached by a potential buyer.

Obtain a Proper Valuation

When you transition ownership within your company, you are really transitioning value.  To understand the amount in dollars that must be bought and sold, as a starting point, you must know the value of your company.  From there, you can begin to consider how to best plan for transition of that value.  There are a number of different ways that owners determine the value of their business.  These range from educated guesses to values based on an established formula to detailed valuation reports prepared by qualified appraisers.

We have found that, in practice, the best valuation method is a hybrid approach that considers both a company’s adjusted book value and an earnings factor based on historical income.  This hybrid approach works extremely well for internal ownership sales where buyers will acquire both the assets of the business and its future earning power.  Utilizing a weighted average of the earnings from recent years will help to smooth out major fluctuations in value during periods of significant economic change.

Consider the Non-Financial Aspects of the Plan

Often one of the most challenging non-financial aspects of the plan is determining how the
selling owners will eventually “let go” of their myriad of responsibilities.  Criteria for ownership must also be established to help understand how key employees can progress on their path to
future ownership.  The plan must also address the transition of management and other key operational roles and customer relationships.

Evaluate the Mechanics of the Plan

A proper business succession plan is one that will mesh the goals of the selling generation and that of the buying generation and address the key concerns of timing, affordability, tax efficiency and cash flow.  While it is critical that the plan be financially beneficial to the sellers, it is equally important that the plan be affordable to the buyers.  This will often lead to a plan that involves gradual cross purchases of ownership and funding with payments over a period of years.  Other possible vehicles to consider, include deferred compensation, stock bonuses and stock redemptions.

Formalize the Plan

A mandatory step in the plan for ownership transition is the adoption of a comprehensive agreement among the owners that is often referred to as a buy‑sell agreement.  For companies with existing agreements in place, the agreement should be reviewed to ensure the company’s ownership transition planning objectives are being met and the agreement is current with respect to the current economic and tax environment.

A buy‑sell agreement should be a “self‑executing” agreement that will accomplish all of the following objectives:

  • Provide for the orderly transfer of ownership interest upon the death, retirement or disability of an owner;
  • Create a market, at a fair price, for the interest of owners who desire to transition their ownership in the company for expansion or in contemplation of retirement;
  • Fix the value for sale and/or purchase and the related payment terms; and
  • Reasonably assure the continuance of the business and reduce the risk of dissolution and loss of value.

Contributing author: Victor W. Vaccaro, Jr., CPA/ABV, CFF, CDA, Audit Partner at Dannible & McKee, LLP, has over 30 years of experience providing auditing, accounting and consulting services. For more information on this topic, you may contact Vic at vvaccaro@dmcpas.com or any of our tax professionals at (315) 472-9127.