In episode 15 of The Legal Way, we are joined by estate planning attorney Alex Gusikoff to explore the often overlooked topic of business succession planning. While estate planning is commonly associated with family, many business owners fail to consider what will happen to their enterprise after they’re gone. Alex delves into the critical steps and considerations to prepare your company for a seamless transition when you decide to step down or retire.
EPISODE TRANSCRIPT:
Alyson: Hi, everyone. And welcome back to The Legal Way by Friedman Schuman Layser . My name is Alyson Layser and I’m your host. I’m also the director of marketing here at Friedman Schuman Layser . And today I’m going to be joined by another guest who has been on the podcast before Alex Gusikoff. He is one of our estate planning attorneys here at Friedman Schuman Layser . And today, while we’re going to be sticking along the same lines of estate planning, we’re going to be switching it up a little bit and introducing business succession planning. And I’m really excited to chat about this topic because it’s not really something that we have really delved into very much. So, I am going to let Alex introduce himself a little bit and then we will just dive right on in. So, Alex, feel free to introduce yourself.
Alex: Sure. So, my name is Alex Gusikoff. Like you said, I’m an attorney in the estate and trust department. I think critically, one piece of the work that we do in the estate and trust department, involves critically business planning and it’s often something that clients will not consider or won’t think about something in the back of their minds and it is only really raised when they’re considering their estate plan. You know, someone comes in thinking they need a will and, by the way, I happen to operate my own business. What do I do about that? So that’s usually the reason that, you know, someone comes in and has this kind of conversation, but…I think to your first point, often it’s not a conversation many are ready to have.
Alyson: Absolutely. And as we were talking a little bit before recording, I was thinking, when we think about estate planning, we think of family. We don’t always think of business. And so I think it is a topic that’s really important just to bring about for entrepreneurs and…just other people who have their hand in different types of businesses. So, I’m excited that we’ll be chatting a little bit about it. So, can you just start off and just really explain what exactly is business succession planning?
Alex: Sure. So, really the question business succession planning is exactly what it sounds like, right? Who’s going to succeed in your business. But it’s a little more complicated than that, as you might imagine. Really, it boils down to what happens to your business when you’re no longer alive, when you’re not there to run it and you’re not operating the business, what happens to it? Often entrepreneurs, business owners, it’s the last thing on their mind, right? Their own mortality. They’re busy running their business and making it successful and making it grow to where it is. And that’s their primary focus. So, what happens when they’re no longer running it is not top of mind. And often, like I said, is only really part of the conversation when they’re thinking about their personal estate planning documents. When the prospect of your own mortality becomes tangible, you start to think about these issues. But before that, you really don’t have occasion to. So, it’s only when they come and see someone like us, they visit their attorney and say, I need to get documents prepared, that something like this comes to top of mind. So I think one of the most important parts of this pod and what I want to express strongly is that, the most important part of the business succession planning process is to begin. Start thinking about it. If you own your own business and you haven’t given it any thought, and you probably haven’t, then it’s an important time to consider what happens when you don’t run your business. Now, part of that, often, like you mentioned, thoughts of family, are my kids involved in the business? you know, who’s going to take over? Is it going to continue? Is it going to cease operations generally? You know, those are all things that are important to think about. But before we delve into the rest of the nitty gritty of what succession planning actually looks like, it’s important first to actually consider doing it in the first place. You have to know that you need to do it. So, I think that’s important to outline is the business succession planning is what happens when you die and what happens to your business. And most haven’t thought about it. So, it’s critical that you do.
Alyson: Absolutely. And that reminds me of some of our other podcast episodes, right? You said the exact same thing just about estate planning in general.
Alex: I don’t want to be a broken record, but advice rings true.
Alyson: It really does. It really does. So, you mentioned documents just a little bit ago. Can you explain what types of legal documents are necessary for a business succession plan and what somebody should maybe have at the forefront of their mind when they’re starting to think about this?
Alex: Sure. So, I think before we jump into necessarily the documents themselves, I think it’s probably important to touch on a few of the key decision points when thinking about the succession plan, because this will inform what documents you think you need to prepare and what you have in place. So ultimately, the small family-owned business operation is usually going to be kept in line. The next generation is looking to take over, or at least that would be our default imagination. Of course, that doesn’t have to be the case, but in the family context, you’re often thinking, okay, when the business owner dies, are we going to keep this business in the family? Are we going to sell it to a third party? If we’re going to keep it in the family, which family members have an interest in participating in the business? Which of those family members have already done so? Right? Who’s already involved? And if there’s someone who’s not involved, might they become involved in the future? Is there an interest in having them become aware of the business and how it operates so that they can continue to carry it on? Or is at least there’s someone that might be available to assist in winding down the business when you’re no longer available? Someone with financial acumen or otherwise. Another important question, if you do keep the business in the family, who is the manager? Right? That’s ties into the question of who’s got an interest and who’s going to retain that interest, but who is managing the business?
Alyson: That’s a big, big question.
Alex: It’s a huge question. It is the question in most cases. If you plan on offloading some of that business, another important question is, is this going to be a transfer of your business interest during your lifetime? Right? You know, I mentioned at the outset what happens when you die, but…there is always the prospect that we do some lifetime succession planning that says, I’m going to peel off some part of my business interest during my lifetime and give that to, you know, parts of members of my family or some third party. You know, we need to peel down my involvement so that, you know, I can retire or fund my retirement with, you know, with the proceeds of that business sale. So, it doesn’t necessarily have to be only a testamentary, you know, at death. consideration, but it’s really a full, all -encompassing plan that can happen during the lifetime. So that’s also important because often, especially as business owners get older, start to slow down, are unable to maintain the level of work that they were when they were at their younger years, it’s often the case that the next generation is taking over. They’re essentially running the business while the business owner, say, father, son, father is still running the business and owning it, managing it, but son is taking over and doing most of the day-to-day operations. Maybe that lifetime gifting strategies are a good idea. You know, we, you know, I won’t get into the tax complications of that, but often, you know, that’s driven by either a tax consideration or a relationship kind of circumstance where you say, okay, you know, you’ve been involved in the business, you know, that son, daughter, what have you, now it’s time for you to take over. I’m going to give you my interest. So, all of those are important considerations in the family context. Now as to some of the important documents that are critical in that process, I like to separate these into kind of two buckets. You have the estate planning documents for the owners, right? That would be a last will and testament and potentially a trust of some kind, either a revocable or irrevocable trust. And then the other bucket are the business documents. So, depending on the kind of business it is, depending on how it’s formed, whether it be a corporation, LLC, you know, closely held sole proprietorship, then we may need an operating agreement or a shareholders agreement. There may be a buy-sell agreement, which in short, anyone unfamiliar, a buy-sell agreement is often used in conjunction with the operating agreement. that says when I pass or when something, some triggering event happens, I’m incapacitated or die, then there is a mandatory transfer clause that says my interest in the business will be transferred to this person and the purchase will be funded with proceeds from say life insurance policies that the corporation or business has on the owner of the business to help fund that purchase. So, there are a couple other documents that you might need in the business part of it, if, depending on the structure of that business, I think a lot of those are a little more ancillary, but the most important being the operating agreement, because the operating or shareholders agreement in a corporate setting, because that is going to dictate the transfer restrictions on the membership interest or shares. And say, can you transfer these shares? What are the restrictions that govern the transfer of those shares? It may be that it’s advisable to have some kind of a right of first refusal to give an opportunity to a third party to purchase an interest. And if that isn’t appropriate at that time, then something else occurs. But that operating agreement is going to be critical in governing what happens when a shareholder or owner dies or otherwise transfers their interest. So that is a very, very important part of the planning. So, I think it’s important to keep those two buckets separate, but they’re interrelated.
Alyson: Gotcha. That was going to be one of my questions, if those two things could overlap at all, which I’m sure in some sense they do, kind of, but like you said, better to keep them separate.
Alex: Certainly. So, you know, the documents are usually going to overlap in terms, because they’re all encompassing, right? As part of your plan, that is going to include…whatever business interests that you have in the succession plan that it involves. So, your estate planning is always commingled with your business succession planning. Or I shouldn’t say always, it should be.
Alyson: It should be. Gotcha. Going back to the family business scenario, let’s say for example, grandfather owns a business, plans to pass it down to his son, but also would want to write in something about his grandson then taking over the business. Like how far in advance, could someone plan for their business’s future in their business succession plan?
Alex: So, usually you’re really only talking about the transfer to the next generation of whoever is operating the business. Because once that person takes over, or those people take over, now it’s their business. Now they’re managing and operating it. So, you know, as much as it may be tempting, I think, for business owners to, in a similar way that they might want to control from the grave, you know, in the will, they’ll want to control, you know, their business because, and it makes sense, right? Especially in a closely held circumstance, you know, someone thinks, I built my business, this is mine, you know, from the ground up, and I want to make sure that, you know, it stays intact and doing the right thing. But…some part of this process involves letting go. So, I think that’s important. And usually, that’s one of the bigger hubs we have to get over, is having these conversations is letting go. So usually, one generation, who’s taking over and who’s gonna run the business when I’m no longer, that’s the plan. But as far as multiple generations of managers or owners or what have you, there are means to restrict the transfer of ownership to keep it in the family. Whether or not that’s a good idea, you have to speak to your attorney about that. That’s what we’re here for. But yes, the short answer is yes, there are means to restrict transfers, but ultimately, in most circumstances, it’s going to be one restriction to the next generation who’s going to be taking over.
Alyson: Yeah, that absolutely makes sense. I was just curious about that. So, we’ve talked about the legal documents and everything. What if somebody is about to start planning their business succession plan, what are some key steps that they should be prepared for?
Alex: So, I think the most important in even considering the business succession or lifetime gifting is understanding the value of your business and where that currently sits. So, part of that is understanding the value of your business and where that currently sits. So, part one of this process, whether it be lifetime or testamentary, usually involves obtaining a business valuation. And so, a business valuation is critical because depending on the kind of business it is, the kind of industry that it is, what valuation method is employed will be critical in accurately assessing the value of that business so that when the time comes, the business assets are appropriately valued, whether that be for a third party or for a family member. Some important considerations in the valuation, like I mentioned, the kind of industry, whether or not that there’s significant inventory that’s held or whether or not it’s a very service-based kind of business. Now, like I said, there’s a number of valuation methods. Usually, if there is an accountant involved and often. If you have a business, you have an accountant.
Alyson: I would hope that there would be.
Alex: You can work with that accountant to obtain a preliminary valuation, especially if you’re going to be doing a family succession plan, keeping it in the family as opposed to a third-party sale, then that accountant may be a good resource to be able to prepare a preliminary valuation, direct you as to which valuation method would be most appropriate. But ultimately, that is the most important piece of this is understanding what your business is worth and understanding how it is you would go about selling it if and when we need it to. There are a few challenges in coming up with that valuation. Often, it’s a moving target, obviously, and the valuation will ebb and flow as the business does. But I think getting that initial valuation to understand where you sit is critical. The other piece of that that’s important here is, you know, if whatever that valuation comes to, it’s important to see what value the owner of that business, you know, is bringing to it themselves and what the likelihood is that that business can continue when that person’s gone. And this is really critical in service industries, you know, forward-facing industries where there’s a close relationship, perhaps just between business owner and clients, where if that trust and that client relationship is critical to maintaining the business and the owner dies or is disabled, incapacitated, can’t maintain it, and his family or someone else has taken over, that relationship with the client may break down. And it may be that as good as your business was when you were running it and all your clients loved you, they don’t love your son nearly as much. And if there’s not enough time to either transition that client over to help migrate some of that, build a relationship, or otherwise deal with how that transition will work, clients may lose trust. They may decide to go another route. So, you know, it’s important as critical as the valuation is, it’s also important, I think, to understand what kind of business you’re in and what kind of client relationships you have, where your revenue is coming from, and how to maintain that if and when you’re no longer doing it yourself. Because, you know, I’ve seen circumstances where, you know, clients think about everything and anything besides a client transition, and the time comes to move the, make the transition, move the clients over and they don’t like the new owner. They don’t want to deal with him. It’s difficult to deal with. The transition didn’t go smoothly and they decide to go somewhere else. And suddenly, despite your valuation and what the business looked like a couple years ago, suddenly you don’t have any clients because they don’t like new ownership. So, I think that is a really important piece of the planning process is, especially if it’s going to be a lifetime process, but regardless involving that next generation in your business so that the transition is that much easier when the time comes. Because it’s really difficult if you just drop everything and start over. You have to start with a new person. You can imagine the client saying, I was working with dad for 50 years and now I’m working with son and son doesn’t know anything about this business. And I’m going to…forget it. I’m going with somebody else. So that is really important to consider.
Alyson: Yeah, that scenario actually reminds me of..have you heard of the show succession?
Alex: I have I’ve heard of it. I have not yet gotten a chance to watch it.
Alyson: I have not watched it either. My mom, my brother both watched it, loved it. And they were talking about how the father of his family passed away and had, I think, four children and he didn’t have anything in place. And so, the four kids are basically trying to figure out how to start running his business. But apparently, it’s pretty funny and sarcastic and stuff like that. But I would like to watch it, but it reminded me exactly of what you were talking about.
Alex: That sounds right on point. Well, I guess funny and sarcastic when it’s on the show.
Alyson: On the show. Yeah, not in real life.
Alex: It’s a good point, too, because I think, you know, often you can get a misunderstanding of, you know, kind of, well, things are happening and the business is being run and family members are clamoring. You know, you don’t want to have any surprises in this process. Surprises, you know, that is the reason that ultimately you come to attorneys like us. Yeah. You know, you want to build that relationship with your attorney, make sure they understand what your plan looks like, what your intentions are, and can help you answer some of these questions. Because they are important questions and they’re difficult questions. It’s not all the time that, like I said, business owners are not thinking about this. It’s not top of mind. You’re not thinking about what happens when you die. That’s why, ultimately, attorneys are here to talk about it. You have to have that conversation and having someone there who’s able to direct you in the right way, ask the right questions, and prompt some of these conversations so that you can think about some of these issues that you never had occasion to think about.
Alyson: Absolutely. And on that same note, what would happen if a business, for example, or a business owner just completely failed to create a business succession plan? Like, what are some things that could happen to that business moving forward?
Alex: Well, I mean, if…there’s a laundry list. I guess the short answer would be you’re making a nightmare for your family. I mean, just to take an example, if you had, say, a sole proprietorship, a contracting business, and it doesn’t have any documents in place, he probably has some unfiled tax returns or some bills outstanding, and doesn’t have his estate planning in place. He has no will, no existing business succession documents. His family is left up a creek in some sense. They’re gonna have to petition for letters of administration if there’s no will to be able to obtain authority over his estate. And then we’re gonna have to gather all of the information about what was going on with this business and file unfiled tax returns, pay outstanding debtors, collect money from clients for invoices and bills, you know, the list is endless in some sense. I mean, you have to take over the business and finalize and wind it up if assuming that it’s not going to continue to operate. And that’s a lot. That’s a lot to ask, especially when you’ve got family members who, you know, they may have no information about this business. You know, I’ve had clients, almost exactly the circumstance, you know, dad ran a business for 50 years, had no plan in place, and he leaves his sons having to gather all the information, deal with the business when he’s no longer here, and they don’t know anything about it. They have to go run down the accountant and try to pull tax returns, get in contact with various vendors, and it upends their life in some situations, especially if the business is complex and sprawling. So those obligations can be significant, and it just underscores the point of why it’s so important to have a plan in place. You really take a lot of the burden off of your successors by being mindful while you have the opportunity.
Alyson: Yeah, absolutely. Next question for you is how far in advance should business owners really start planning for their succession? If somebody today, they’re about to start their business tomorrow, obviously they’re more concerned with getting their business up and running probably and they don’t necessarily have like evaluation of their business at that point. So, when should they start really putting that plan into place?
Alex: So, similar to my normal estate plan in caveat, I’ll say, well, it’s always good to have a plan in place because it is, you know, it is always good. Now for a new business who, you know, you just started off the ground, you don’t have any clients yet or, you know, a small book of business, you’re not really making any money. Doesn’t much matter to you what happens, right? When, but, you know, to the point about, obligations for family, having to ease their burden is important to have it in place regardless. But really the important piece is when you have a business that you imagine will either continue to operate past your death or you’ve got family members who are involved. So really, the earlier the better, I guess is the short answer, the earlier the better. But before at least, five to 10 years before you plan on retiring. If you’re thinking to yourself, well, gee, I really want to retire next year, and I haven’t gotten anything in place and I don’t really know what I want to do about this. It’s not too late, don’t worry. But there may be some options that are more limited when you don’t plan and wait until the end of your career. So, depending on when the business started and how it goes. You know that that answer will vary but I’ll say do not wait until you know you’re ready to retire to say okay now I have to start thinking about it. You know, when when you start to generate some business for yourself, you’re standing on your own two feet, and you know have an idea as to where this is going, you know, you’ve been been doing it for a little while, you know, you can see the future but also see the end, you know where you want this and your involvement to be then, you know usually five to ten years before you think about retirement then that’s a really, really important time to start thinking about it. And usually, like I said, that will coincide with your estate planning. So, when you’re calling your attorney to talk about a will, they’re going to ask you, do you own any business interests? And when you tell them that you do, this should be shoehorned right in.
Alyson: Yes. Absolutely. Thank you. That’s very helpful. So, we talked about some of the challenges that can be faced. you know, if you were to not create a business succession plan. But what about in the process? Are there any common challenges that business owners can face when they’re starting the process or when they’re in the thick of it?
Alex: So, some, some interesting issues can pop up. Usually, you know, it’s going to be around selection of successors, right? You know, a lot of the intangibles, it’s not primarily, you know, financial considerations. If there’s no one to take over, then that’s gonna throw a monkey wrench in. So, then you’re really talking about is this a business that I could sell? Is there a market for a third-party buyer? If I do, what’s the valuation? What could I possibly get if I’m looking to sell this? Are any employees gonna be involved? So, there’s complications in that during that process, those conversations with family may be difficult. If you’re…you’re having to have a conversation with say, you know, two sons or, you know, multiple family members who are all involved and you’re having to make a decision as to who’s going to be the manager, who’s going to run the show. That can be a difficult conversation. So, you know, a lot of those interpersonal issues are probably the most challenging in this process. As far as what to do and how to do it from the financial end, you know, there can be some challenges as far as funding some of the, you know, a death purchase. If for instance, you know, we wanted to say have a mandatory purchase of the business interest by a family member at death. We said, you know, when I die, the businesses were gonna put a value of the business of X based on this valuation. When I die, you’re going to pay to my estate Y and receive these shares of kind. And you’re gonna pay that over the course of X number of years on a promissory note. Well, there might be a question as to how the successor who’s taking your interest will fund that purchase. How are they gonna go about buying your interest? How is that being paid for? So, there might be some complications in obtaining financing or thinking about, usually life insurance is a good option to fund some of those purchases. But it may be that depending on when you start this process, life insurance is either too expensive or completely unobtainable. So, you know, and that reiterates again, you know, how important it is to start this earlier rather than later. You know, some of those options can be taken off the table. If, you know, from the life insurance context, particularly, if you age up and you’re too old and the premiums are too expensive, it may no longer be an option for you. Whereas if you were, you know, 10, 15 years younger, you were able to purchase a term policy or something like that at a more affordable premium, then that becomes an option that’s available. So, I think those are some of the challenges, but really, really critical are who’s gonna run the business. That I can’t underscore enough. Who’s gonna take over as the successor and who is responsible for running this business is a key, key question.
Alyson: Yeah. Are there any differences in a business succession plan? when someone is deciding whether a family member should take something over as opposed to someone that wouldn’t be a family member would maybe be like, for example, someone’s a CEO and they want to pass it down to like the CFO or something like that. Are there differences there? Alex: Certainly. So, you know, there are outside of the tax impacts, which we can kind of put to the side, there’s going to be some questions again as to funding. If we’re gonna make a transfer to a third party, because there could be some tax implications from the kind of structure that we use to do that. In the family context, some of the lifetime gifting strategies are available that would otherwise not be available in a third-party situation. There’s also a question of, you know, if that third party is going to take over, what their obligations would look like and how they’re going to transition. In doing that, if they have, usually it’s gonna be someone who’s involved in the business, like you mentioned, if an owner picks the CFO and says, I’m appointing you as the next. So that can be a little bit different, but really it’s a question of what is, what’s going to happen as far as financing for a purchase or if we’re going to do some kind of a gifting, what are our options? Because it’s very, very different in a family context and a third-party context.
Alyson: Interesting. This is all very interesting. And I know that I say this with every single episode, but I learned so much. So, before we wrap up, because I think we covered pretty much all of our questions, is there anything else that you would like to touch on or just discuss in regards to business succession planning?
Alex: I think, you know, really, I’ll just reiterate the main themes that I mentioned, you know, throughout our conversation today. But again, I can’t underscore enough the importance of starting the process, beginning, you know, to think about these issues, because ultimately, you know, that’s the biggest hurdle to get over, is actually engaging in the process. You know, properly planning for a business transfer is, you know, in my view, as important as preparing the remainder of your estate planning documents, you know, your will, your trust, what have you. And it’s going to require difficult choices to be made, and it’s going to take an investment of time. It’s not something that you’re going to be able to figure out overnight, and the answers aren’t going to be there readily. So, it is a process, and I think it’s important to understand and appreciate that. starting the process and carrying through that process is involved and unfortunately, you know, it results in some difficult conversations, but it’s critical. There’s just no underscoring that, you know, more strongly. It is critical that you begin the process and start to think about these things, especially when you’ve got heirs who are interested. You know, they want to know what’s going to happen. It’s probably something I’d fail to mention here, but you know, ultimately, the family members who are taking over, they want to know what’s happening too.
Alyson: That’s a very fair point.
Alex: They really want to know what’s going to happen and what the plan is and why the plan looks this way and not that way. So, all of that underscores, again, the importance of beginning this process, having that conversation and having that candid and difficult conversation. And ultimately, if you don’t know where to begin, you don’t even know where to start with any of this, that’s where we come in. That’s why we do what we do. That’s what the attorneys are for.
Alyson: Absolutely. Well, thank you, Alex, so much for sharing all this. Again, I learned so much and I’m sure that our listeners did too. And I hope that all the entrepreneurs, business owners that tuned in, that they are preparing to call you very, very soon and get some help and some insight as they start to plan their business succession plan. So, thank you again. As always, love having you on the podcast.
Alex: Thank you so much, Alyson. It’s always fun.
