Developing an ownership succession plan is typically a multi-stage process. To keep things relatively simple, we summarize some of the major steps below.
It’s important to remember that the question of management succession— who will run your business in the next generation—is closely related to planning for ownership succession.
If possible, your ownership succession plan should take into account which family members in the next generation are likely to play an active role in the business, and your plan should allocate ownership interests accordingly. For example, it may be appropriate to transfer more ownership interests to individuals who are expected to be active in the business and make equalizing transfers of different assets to others.
The process of ownership succession planning can vary from person to person but often involves the following basic steps:
Step 1: Create a personal balance sheet
A personal balance sheet is generally an itemized list of your property (your assets) and your debts (your liabilities) with values assigned to each, as well as an indication of how property is titled, e.g. in your name individually, jointly with your spouse, in trust, and so on.
Creating a personal balance sheet is the equivalent of setting up the game board before you play. It’s difficult to plan what assets go where—and to whom—until you’re fully aware of everything you’re working with. Another critical step can be to anticipate whether future transfers of wealth to family members or others are likely to be diminished by transfer taxes (e.g. estate and gift taxes).
Step 2: Identify goals and priorities
This is the core of the succession planning process and typically starts with identifying your broad personal financial goals. These may include providing for sufficient income and cash flow to meet your lifestyle needs in retirement and, if your wealth is sufficient, leaving a financial legacy for the next generation.
The nature of your broad goals may logically lead to a specific objective, such as transferring your ownership interest when you retire to a family member or co-owner (often under the terms of a Buy/Sell Agreement among the co-owners) or to a third party.
Alternatively, your broad goals may lead you to transfer some or all of your ownership interest to family members either during your lifetime or at your death. In addition, you may need to set priorities among certain (sometimes conflicting) goals, such as retaining control of your business during your lifetime, minimizing taxes, maximizing your family legacy, charitable giving, and protecting property that you transfer to family members from loss due to lawsuits or unsuccessful marriages.
Step 3: Identify challenges in achieving your goals
After you establish your goals, it’s important to identify and understand the principle challenges that you may face in attaining them. For example, if your goal is to sell your ownership interest, capital gains taxes can reduce the net proceeds that you will take away from the sale—and reduce the amount that you have to live on in retirement.
Alternatively, if you are contemplating giving ownership interests to your children, transfer taxes may reduce the value of this legacy. Also, gifts of ownership interests to your children may expose those assets to loss should your child be sued or have an unsuccessful marriage.
Of course, every situation is different, and you may face some or none of these challenges—or entirely different challenges.
Step 4: Create an ownership succession plan
Once you’ve clarified your goals and challenges, you can explore different planning strategies and options to consider with your tax and legal advisors and select the succession plan that best meets your situation.