Ask the Experts: Protect your business’s legacy with a proper plan

Whether you’re planning for retirement, preparing the next generation to lead or ensuring your company’s long-term stability, a solid succession plan is essential.

Whether you’re planning for retirement, preparing the next generation to lead or ensuring your company’s long-term stability, a solid succession plan is essential. Our panelists share practical insights on valuation, legal strategy and transition planning to help business owners protect what they’ve built and ensure a smooth handoff to future leaders.

Panelists: Alyssa Hodges, CPA, CVA, Mason + Rich, masonrich.com

Jeanne Saffan, attorney, Upton and Hatfield, uptonhatfield.com

Nick Mason, attorney, Shaheen & Gordon, P.A., shaheengordon.com

Alyssa Hodges, CPA, CVA, Mason + Rich

What role does an accountant play in the early stages of business succession planning, and when should business owners engage your firm in the process?

As accountants at Mason + Rich, our goal is to be more than compliance partners. We work with business owners to help establish or understand what drives value in their business. Understanding what drives value, whether it’s revenue growth or other performance metrics, helps establish informed decision-making. Ideally, this mindset should start early, but it’s never too late to begin.

For example, if the value is based on revenue multiples, investing in marketing or additional staff may yield the best return. If value is tied to Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), strategic investments in equipment or efficiency may be more beneficial.

We also help clients understand normalization adjustments that impact valuation, such as adding back above-market owner compensation or other non-recurring expenses. When business owners understand these adjustments, they gain a clearer picture of how their normalized financial performance impacts the value of their business.

Why should you think about succession planning if you want to give your company to your children?

Giving a company to your children is not as straightforward as you may think, particularly with multiple children who might contest the gift or may not see eye to eye. There are a few different options for moving your business to the next generation: gifting, inheritance or a sale.

When you have multiple children, particularly some who are not interested in running the business, it can create difficulties moving your business to the next generation — especially the children who are not involved, who often believe they are entitled to an equal share. Depending on your goals, there are ways to transfer your wealth in fair, equitable ways. One of those ways is to have a valuation of your business prepared, which establishes a fair price. Once the value is established, there is a baseline for selling your business to your children and/or allocating other aspects of your estate to your other children of similar value.

It’s also important to plan for the unexpected. Establishing your business with a clear succession plan is crucial to ensuring it transitions to the family members you wish to inherit it. For example, without a well-defined plan, your children could inherit your business equally, even if they aren’t interested in running the family business. With proper planning, business values can be established and agreements, such as a buy-sell agreement, can be put in place to ensure a smooth transition of ownership.

Jeanne Saffan, attorney, Upton and Hatfield

My daughter, the youngest of my three children, has been working in my business and is serious about being my successor upon my retirement. (My other children have chosen different career paths.) She will not be in a position to buy the business outright, and my spouse and I want to continue to receive financial benefits from the business during retirement, but do not foresee a continuing role. We want to reduce the size of our estate and treat all our children fairly through our estate plan. What is the best way to proceed?

Good job! You have identified your successor and your personal long-term goals as you approach retirement and are developing the next generation of management well in advance of the transition.

STEP 1: Will the business be able to meet your financial goals, and which transfer technique is best? Many people think that they can live on a percentage of their working salary, but this is often unrealistic. Do not assume that your spending will go down. Obtain a “qualified appraisal” of the value of your business to determine whether it will meet your financial goals. Next, review the various techniques available for the transfer of a business with your attorney.

STEP 2: Transfer the Business. Having reviewed the various techniques, you might choose the installment sale to an irrevocable trust. This method enables you to remove the asset from your estate as well as the future appreciation. We recommend that the sale take place over several years, so you can maintain control of the business until your daughter is ready to take over. Briefly, shares of the business are sold to the trust in exchange for an interest-only promissory note payable to you. The trust must make annual interest payments to you, and payments of principal as the business income allows.

This is a tax-efficient plan, and there is always a risk that the IRS could challenge either the valuation of the business or the amount of any discounts taken. The valuation should be well documented, and you should be prepared for an audit.

STEP 3: Estate Planning. Having received payment for your business, you will be able to distribute your estate equitably among all your children. Your estate planning attorney will discuss your wishes in that regard and provide you with a well-documented estate plan that accomplishes the goals you have set forth.

Nick Mason, attorney, Shaheen & Gordon, P.A.

What role does an attorney play in business planning?

It’s an attorney’s job to balance a client’s concerns about their business. Most of the time, that means reassuring them. When it comes to business creation, however, it often means bringing up risks the client hadn’t considered. Their departure, for instance. No one wants to imagine leaving the company they’re founding, but it’s an important topic to consider. Whatever the reason, no owner stays with their business forever. But once things are up and running, it is much harder to determine how to divide up the company and divest in an orderly manner.

What is the value of a succession plan?

Your succession plan should be clear, concise and actionable.

A clear road map reduces the chances of costly and time-consuming conflict when a sale does have to take place. If you do not have a process for how to trigger, proceed through and close out a buyout, you will have to invent it on the fly. This will take time and a lot of arguing, when you would rather be running your business.

An earlier agreement may also be fairer overall. If you are inventing a process, once you know who is buying and who is selling, then you will want a process that best protects your side. But if you are designing a process before you know who will be leaving or staying, your best bet is to be as fair as possible.

Lawyers may love process, but for a business owner, the real question is about the bottom line.

How can businesses calculate their value?

The most important inclusion in a succession plan is a formula to calculate the value of the business. There is no simple way to reduce a life’s work to a number. You could add up all assets and divide that by an ownership share, but that would not necessarily result in a fair price. This type of asset-based valuation is generally only used in total liquidation scenarios, where the business will close after the sale.

Most business sales will use an earnings-based approach instead. This takes the business’s EBITDA (earnings before interest, taxes, earnings and deprecation) and applies a multiplier, meant to represent future earnings potential. Then, a partner is paid out their share of that earnings-based value. If a company made $1 million last year, and the partners have agreed on a 2x multiplier, a 30% partner would be paid $600,000 (30% of $2 million).

That is a clean solution, but not always an accurate or fair one. For instance, what if last year’s earnings are unusually low for some reason? Say the company made major capital investments that are expected to greatly increase profitability in the next year, or major accounts receivable are due in the next year for contracts secured in the current year. Should that be counted?

This is where a mixed approach that combines assets and earnings is useful. Accounts receivable are an asset of the company and would be reflected in an asset-based approach, but might be disregarded in a pure cash flow evaluation, because the money has not yet been paid. Meanwhile, known risks like lawsuits, major debts and the like can reduce the overall value — and if not accounted for, may end up with an unfair sale price. But a well-designed, mixed agreement could account for capital expenditures and include near-future accounts receivable in addition to the multiplied earnings approach, resulting in a fair transfer of ownership for all involved.

Ultimately, much of this will vary depending on the business. A bakery with two owners will use a totally different formula from a tech company or a factory with dozens of institutional investors. Regardless of what shape your business takes, the knowledgeable attorneys at Shaheen & Gordon can help you establish a plan that fits your specific needs and will save you time and turmoil when you — or one of your partners — ultimately leaves.