Legal Aspects Of A Succession Plan
Categories: Blog, Strategic Planning, Succession Plan
Guest Blog Contributor, Scott D. Calhoun.
Use Your Team To Formulate The Right Plan For You, Then Organize All Your Paperwork
As we discussed in our earlier articles, formulating a proper succession plan starts with putting together a good team of advisers. At a minimum your team should include your attorney and CPA, and you might consider adding an outside financial consultant to the team. Think of your team as a coaching staff putting together a game plan. Once all the coaches have met and hashed out various ideas, a master plan is put together. As game day approaches, steps are taken so that the detailed game plan can be implemented. Among those steps is putting your legal affairs in order, including:
- Update (or make plans to update) your will or other testamentary documents
- Make sure your corporate minute book is up to date and complete – including stockholder records and minutes
- Confirm that all your corporate registrations and business licenses are current
- Put in place all agreements with current employees that are necessary to preserve the value of your business – non-disclosure/non-solicitation agreements, existing shareholder buy-sell agreements, stock option or other equity participation plans
Next Comes Implementation Depending on the Nature of the Succession
If your plan calls for an INTERNAL succession (an existing partner or employee, or a targeted successor candidate, or a family member), several different arrangements could be used:
- Transfer through existing buy-sell agreement
- Establishment of stock option or other equity participation and transfer arrangement
- Transfer through gifting program or limited partnership (especially useful with family members)
Each of these structures produces its own legal challenges and requires that specific issues be addressed. With respect to buy-sell agreements, you will need to focus on:
- Triggers – buy-sell agreements can provide for the purchase and sale of stock in many circumstances other than death, including disability, separation or retirement, divorce, or even upon achieving certain performance goals
- Valuation – how the company is valued at the time of the buy-sell is critical, and the methods of determining value are quite varied. We strongly encourage you to decide on an appropriate valuation methodology at the time of putting the buy-sell agreement in place
- Funding – perhaps the most important issue, how the buy-sell is funded can be the difference between a successful succession or the collapse of the business
If you are implementing a stock option or equity participation (or phantom stock) plan:
- Appropriate grant percentages and formulas – the goal of these plans is to provide incentive for performance and also “skin in the game.” Careful thought is required to ensure that these incentives are appropriate but not excessive
- Triggers for payout – when will the stock be awarded or the compensation paid? On sale of the business? Other restructuring? These are questions that need to be answered
- Amendment and correction – these plans need to have flexibility, so the original document should allow for amendment within reasonable parameters
For limited partnership arrangements (can also use LLC) to transition to family members:
- Control – this is a critical issue for first generation business owners. The key point is to determine how to use this method of succession and maintain control until you are ready for the transition to be finalized. This requires some care in planning and drafting
- Gifting program and valuation – using valuation discounts and gifting of interests allows the first generation owner to leverage the gifts and maintain control
- Commitment of family member – this goes back to the issues discussed in our earlier articles emphasizing the importance of selecting the proper persons to take over the business. Make sure your chosen successor is in it for the long haul.
If your plan calls for an EXTERNAL succession (sale to strategic partner, wealth management firm, or purely outside investor):
- Due diligence – during the negotiation process, you will be asked to open your records for the buyer to conduct its due diligence. As a seller, you should do the same to ensure that your buyer is who has been represented to you and that the buyer will be able to successfully complete the acquisition
- Valuation and payment terms – these will be key issues in the negotiation process. An important point to remember is that your notion of what your business is worth will almost never be the same as a buyer’s notion of what the business is worth. Talk to your advisors about expectations
- Security for payments – you will want to make sure you will actually get paid the amount agreed to for purchase of the business. Proper security for those payments is vita.
Defining Your Future Role and Responsibilities – Part of the succession transaction needs to be a clear understanding of what your future role with the business will be. In this regard, you will need to mindful of several issues:
- Consulting or employment arrangements – if the deal calls for you to stay on in some sort of consulting or ongoing management role, your exact responsibilities need to be clarified and your compensation specified. DO NOT allow yourself to believe that just because negotiations went smoothly and professionally, you will be able to “take it as it comes.” Document everything. If there is strong trust, all will go smoothly anyway
- Non-compete agreements – you may be asked to sign a non-compete agreement. This may not be a big deal if you are definitely retiring, but if you need some flexibility, you need to pay careful attention to these terms
- “Earn-outs” – these are a popular means to keep initial purchase prices low. If your deal includes earn-outs, make sure you are satisfied with the upfront and guaranteed money you will receive. You should NOT count on getting any more
- Taking the business back – this issue relates to making sure the purchase price payments are properly secured. If the buyer cannot make the payments, you will want to have the ability to take the business back. But be aware – it may not be worth much if these circumstances occur
No Room For Handshake Deals – In our previous articles, we have pointed out the need to prepare yourself for the transfer, take care in choosing your successor(s), and communicating with your clients and your employees. These are all important factors in a successful succession plan. So is communicating clearly with your team of advisors, especially your legal and accounting advisors. The successful succession of your business and assuring that you receive proper value for your business depend on numerous factors, and the transaction will require careful paperwork. There is no room for a handshake deal, or for whispered “back-room” arrangements with the potential successor. These transactions do not have to be overly complex, but you need to make sure your advisors know everything that is important to you and then you need to trust your advisors to implement your plan successfully.
Download: How Businesses Should Integrate Leadership Development With Succession Planning – Ironstone Whitepaper
What Are Your Biggest Concerns About Succession Planning? Share Your Comments
Scott serves as Ironstone’s Legal Counsel and holds more than 25 years experience in corporate law. Scott has a broad base of experience in the formation and structuring of all types of business entities as well as in mergers and acquisitions. He advises clients on a full range of business matters, including business entity formation, securities offerings, lease negotiations, stock or asset acquisitions, employment agreements, partnership agreements, secured lending or other financial transactions, shareholder agreements, and LLC operating agreements. Mr. Calhoun also has significant experience with estate planning, wills and trust drafting, and estate administration. If you have questions or comments for Scott, feel free to send Scott a message here.
Note, this article is for informational purposes only. Ironstone encourages you to consult with legal counsel.
We would love to hear from you!
Thanks for your inquiry!
We will be contacting you shortly. In the meantime please feel free to connect with us on social media and explore our blog posts.
Ironstone understands the importance of protecting your privacy. We will not sell, rent or give your name or address to anyone.
Latest Blog Article
What The Profit Teaches You About Your Financial Advisor Practice
I’m a huge fan of The Profit, a CNBC show centered around business guru Marcus Lemonis taking a struggling business and helping them turn it all around into profitability. Once he takes on a challenge and invests in their business, he now has skin in the game and deeply cares about getting their team on […]Read More>