David Whitlock will be speaking in Denver at the 2019 Concrete Foundations Convention on drug policies and practices in the workplace.

One of the frequently visited topics at CFA Headquarters, through various communication methods, pertains to business owners nearing the point of retirement. The concern stems from an apparent uncertainty and a lack of planning regarding what resources to consider, along with not knowing what options exist for establishing a path that leads to an easy transition into retirement for the business owners while still making sure the business continues. Though this subject has been presented during numerous Concrete Foundation Conventions, David Whitlock brings a new perspective, as he addresses this issue from his position as an employer advocate attorney.

You have worked incredibly hard to build your business and make it successful. You have invested in accumulating knowledge, skills, experience, and opportunities that have come your way, and the end result is a profitable business with happy customers and honest, hard-working employees. So, what are your plans for the future?

All too often, successful small businesses disappear when the founding principal does. This can be because of a sudden, unexpected catastrophe or simply because of a lack of succession planning. In either case, too few contractors focus on their exit strategy until it is way too late. This is sad, because the result is often that the value of the business is severely undermined by taxes or penalties, and what owners leave behind is far less than what they had hoped.

Smart succession planning is a long-term project. It will take some time and effort, but the end result is well worth it. Let’s look at some of the decisions you need to make and some of the issues that arise.

First, you need to decide what you want to do and establish long-term goals. This involves decisions about your future involvement in the business; the amount of money you need in order to withdraw from the business; whether you want to leave the business to a family member, partner, key manager, group of employees, or someone else; and what sort of legacy you want to leave behind.

In terms of your involvement in the business, sometimes the hardest part of succession planning is letting go. You have invested your life in growing the business, so it is often very difficult to simply walk away. But, as you transfer ownership, you almost always necessarily pass control on to someone else. How active you remain in the business may also depend on what the business needs to remain successful. For some contractors, the owner’s relationships with vendors, customers, subcontractors, and others are critical assets of the business, and you may need to stay involved until your successor can nurture those relationships.

For retirement planning purposes, you need to consider the income stream you need in the future and your current portfolio of investments that will help you reach your desired monetary goals. You may also be considering long-term legacies for your children or grandchildren and how those will be funded. All of this may affect whether you want to cash out completely, take a structured pay-out, remain an investor, finance the sale of the business, etc. These choices have important tax and financial consequences.

The goal-setting process may necessarily involve consideration of the futures of others. In a family business, you will want to take into account the goals and futures of key family members involved in the business. If you are preparing a family member to take over for you, that person’s goals and expectations will clearly be a key factor in the decisions you make about long-term strategy.

You will also want to consider the impact of your departure upon key managers and employees and what their goals for the future might be. If you have partners in the business today, your future plans will necessarily impact them. It is always a good idea to involve partners, managers, and key employees in the succession planning process so that no one is surprised by your withdrawal from the business and the accompanying changes to the business and its operations. This is especially important for managers and key employees who may be tempted to leave during times of transition.

In addition to your personal goals and the consideration of others’ goals, you will need to think of the business itself. Who will run things in your absence? Is that person ready? Are future roles and responsibilities clearly understood? If you plan to sell the business and walk away, management succession may be unimportant to you, and you can leave that concern to the future owner. For most small business owners, however, the matter of who runs the company going forward is a very important concern. Most founders care deeply about the future of employees, the company’s goodwill, customers, the owner’s name, and, especially, family members still involved in the business.

As you contemplate who will assume control of your business, you should understand clearly what will be expected. Often, this requires you to do something you do not often think of: write down exactly what you do. Most owners fill their day with hundreds of different decisions – some small and some large. You will want to define carefully what your present role is and what you accomplish on a day-to-day basis, so that you can identify and prepare a likely candidate to take on those responsibilities. You will also want to make a comprehensive list of all of your contacts and relationships, as this sort of information is usually vital to future success.

Next, you will need to assess the skills of your current management team to ensure that they are capable of assuming control. If not, consider what training they need. You may find that you will divide some of the responsibilities you hold among several managers, but you will probably want to have someone clearly in charge. If you plan to bring in an outside successor, you will want to prepare your current managers and employees for the transition. You will still need to assess the successor’s skill set, so that you can prepare and train the successor as necessary and involve existing managers in that process as well.

Once you have identified your personal and business goals, it is helpful to list some key points so that you can develop the succession plan. A list summarizing your financial objectives, future ownership and business structure, chosen successor and key managers, your future involvement, and any special considerations will be invaluable to the experts you will need to consult to implement a succession plan.

Good succession planning requires input from a variety of experts and resources. In most cases, this will include an accountant, tax advisor, financial planner, insurance broker, and/or legal counsel. These experts will help you pick the best tools for achieving your goals.

One of the first things that your experts will determine is what your business is worth. This is usually a more complicated question than you initially think, especially in a business that is based upon project work. There is a variety of financial methods for determining value, but the easiest way to determine this is to engage an expert. Generally, a good CPA or business appraiser can provide a pretty accurate valuation for your business today and in the future. This will help determine the sale price, creating the income stream for your retirement or other long-term goals. You may also discover that the business is not worth enough today to create the income you want or need tomorrow, in which case, you will want to explore ways to increase the value of the business.

Once you know what the business is worth, you can begin to consider legal options for transferring wealth and control. The legal options you explore will depend in part upon the goals and objectives you identified earlier. It is extremely important to have competent legal counsel for tax and estate planning purposes at this point in the succession process. Here are some examples of plans and tools you can use.

The simplest way out, for those owners who have not or cannot identify a successor, is outright sale or liquidation of the business. Because you know what your business is worth, you also know what you can sell it for (although it is rare that a buyer will want to pay you all of the price at once). More common in an outright sale scenario is an installment purchase. For many owners, this works well because it permits a gradual withdrawal and transition of the business to the new owner, which, in turn, helps ensure that the business remains viable long enough to meet the installment payments. Unfortunately, for some businesses, there is no buyer on the horizon, and the business is liquidated for whatever cash the owner can get. In the case of sale or liquidation, there really is not a succession plan, although there may be some contracts or agreements for sale of assets, inventory, etc.

If you want to keep the business in the family, there are a number of ways to do this. It is important here to recognize the difference between ownership and control. You may very well choose to pass ownership to your family but choose to groom or hire someone to manage the business. The ownership interest can pass through gifts, by establishing trusts, or by selling shares of the business directly. Also, you might choose to use equity in the business as an incentive for key managers or employees, while retaining majority ownership for family members, or trusts controlled and directed by family members.

If there are a small number of shareholders in the business, buy-sell agreements can be a useful tool. Generally, these provide that if and when an owner wants to get out of the business, the remaining shareholders, or the company itself, are given an option to purchase the departing shareholder’s interest. This helps preserve ownership continuity and provides funding for the departing owner.

For a well-established small business, a management buyout can be a useful and reliable way to transfer ownership and insure continuity of management. Here, the owner essentially sells to the existing managers, and they acquire defined percentages of the business equity. Often, they will want to put buy-sell agreements in place to preserve their own ownership interests. In some buyouts, the seller is paid over time and maintains an active, although gradually decreasing, role in the ongoing business.

A slightly less hands-on approach is a sale to employees through an Employee Stock Ownership Plan (ESOP). Instead of limiting ownership to a small group of managers, the entire workforce assumes ownership of the entity. This is helpful where individual managers would not be able to afford to buy out the owner, or where the owner wants to disengage more quickly and be paid in full. This mechanism also provides incentives to employees to make the business a success in the future.

Each of these tools has different tax consequences to sellers and purchasers, so it is vital that you engage an expert to advise you on the impact of each mechanism.

Once you have selected the best succession plan and the appropriate documents have been drafted, the next step is to set a schedule and communicate your intentions to all affected parties. This will usually include family, partners, managers and employees, but you will also want to communicate with customers, suppliers, government entities, etc. In most cases, you will want to transition your business relationships to your chosen successor as you get closer to your target date.

One other important step in your long-term planning is undertaking some interim planning to protect your wealth and assets. Usually, this takes the form of life insurance and health or disability insurance. In some cases, it is beneficial to have key man insurance, which protects the company in the event of something happening to you before your succession plan takes effect.

Note that you should periodically review your succession plan to make sure it will still meet your needs and expectations. Changes in your personal situation – such as marriage, divorce, or grandchildren – may mean you should consider modifying to your plans. Similarly, major changes in business operations or revenues may also suggest the need for plan revisions. Finally, the plan should be reviewed periodically to make certain that changes in tax laws have not affected the plan objectives or assumptions.