The day-to-day operations of a small or family-owned business are challenging enough without the added pressures of planning for passing that business on. But without a well thought-out business succession plan — using estate and financial planning strategies to increase the chances of survival of your family business when you retire, become disabled or die — the business that you have worked so hard to build is at real risk to fail when you are no longer at the helm.

Business owners should carefully consider the “costs” of not planning, or having an inadequate plan, including:

• A loss of the family business due to estate taxes.
• A loss of the family business due to lack of liquidity to carry the business through the period following an unexpected death or disability.
• A loss of the family business because there is no formal arrangement to transfer ownership of a deceased owner’s interest to his or her heirs.
• A loss of the family business because no one has been trained to replace the senior generation.
• A loss of the family business because a family dispute was not contemplated and planned for.
• A loss of the family business because the family of the deceased owner becomes involved in a dispute with his or her partners.

Appropriate business succession planning is very different for each business and therefore a different approach may be required for each business owner. But generally speaking, there are three major areas that need to be addressed in an effective business succession plan: “buy sell” agreements, management succession and estate taxes.

Buy-sell agreements

If a business owner has partners one of the best mechanisms for a smooth transition is an effectively prepared buy-sell agreement. A well-prepared buy-sell agreement will include several “triggers” that will cause the remaining owners to purchase the interest of the departing shareholder. These triggers can include retirement, disability and death, as well as bankruptcy, loss of professional license, divorce and failure to perform one’s duties.

Two common mistakes business owners make when using a buy-sell agreement are to improperly “fund” the agreement and to not provide a means to determine the value of the business shares. A good buy-sell agreement should provide a mechanism, including loans, installment sales, cash or life insurance, for the purchase of the shares of the departing partner by the remaining partners.

A good agreement should also provide a method for determining the value of the business. The departing owner or family members often haggle — or even litigate — with the remaining owner or owners over value. It is imperative that the buy-sell agreement have very detailed procedures for determining the value to avoid these conflicts.

Management succession

Family business owners are notorious for neglecting to have a management succession plan in place. A management succession plan should include a realistic determination of a competent family member who is capable of managing the business in the departing owner’s absence. Such a plan should also account for the different skill sets of the next generation of potential owners and the potential roles they may play. The planning must contemplate any potential family disputes that could destroy the business.

Estate taxes

Upon the death of a business owner one of the biggest business killers is estate taxes, yet many business owners fail to consider and plan for the impact of estate taxes. A staggering nine out of 10 successors whose family business failed within three years of the owner’s death said estate taxes played a major role in their company’s demise, according to the US House of Representatives Small Business Committee.

If the goal of a business owner is to pass the business to another generation of the family the effect of estate taxes is a prime consideration. An effective business succession plan will include strategies to legally mitigate the effect of estate taxes on the business after the owner dies.

Of course, these considerations are just the tip of the iceberg when it comes to what business owners can and should think about.

Effective business succession planning is very complex, requiring a highly skilled and experienced team of professionals familiar with the concepts of estate planning and business succession. This team frequently includes a CPA, insurance professional, financial consultant and attorney. The old adage “you get what you pay for” is especially true in this area. Business owners who try the “do it yourself” method or engage professionals who lack the expertise to adequately develop and implement a proper plan are usually asking for trouble.

Above all, the most important aspect of business succession planning is for the owner to take positive steps now to avoid family business failure in the future.

(Editor’s Note: John Kenney and Doug Lineberry are partners in Lineberry Kenney, PLLC, a law firm that specializes in asset protection and other areas of business and real estate law with offices in Tacoma and Poulsbo. Visit www.lklawgroup.com or email john@lklawgroup.com for more information. This article is designed for informational purposes only and is not intended as legal advice. You should seek the advice of your own attorney or corporate counsel if you have specific questions about the issues addressed here.).