We generally recommend that business owners form a corporation or limited liability company under which the business is operated primarily to limit the personal liability of its owners. During this entity “formation” process, business owners file articles of incorporation/organization and establish bylaws, an operating agreement, and a buy-sell agreement, as well as other initial “governing” documents. However, over the course of months and years of running their business, many business owners rarely review and make necessary changes to these governing documents. Why might you make modifications? Changes in ownership, key employees, or the nature of operations are just a few examples. More specifically, many business owners simply focus on the day-to-day operations without considering how the business is going to maintain long-term survival.
The Importance of Succession Plans
Every business should have a comprehensive and well-reasoned succession plan. The succession plan must address at least the following three issues: (1) What restrictions are placed on the owners’ ability to transfer their ownership interests? (2) Who is going to become active in management of the business (and presumably obtain ownership interests) in the future? and (3) What happens when certain “triggering events” occur with regard to an owner (e.g., death, disability, divorce, termination from employment, bankruptcy; and the desire to sell the ownership interest before or after retirement age)? Every succession plan is different depending on the nature of the business, the owners, and their potential successors. With respect to a corporation, the succession plan is generally contained in a separate document called a “buy-sell agreement” and, with respect to a limited liability company, the succession plan is often contained within its operating agreement.
Protecting Your Family and Business
One of the main reasons for a succession plan is to provide liquidity for the owner’s family when a triggering event occurs. For example, if an owner were to die, the owner’s family may want to “cash out” of the business and receive money for the deceased owner’s equity interest. If there is no agreement allowing a buyout, the surviving family members may be left with a business interest that they are unable to sell or otherwise convert to cash. Equally important is the maintenance of business stability after the existence of a triggering event. For example, a business should avoid allowing an owner to transfer equity to a new owner who will cause conflict. There also needs to be a financially solvent method of purchasing an exiting owner’s equity when a triggering event buyout occurs (e.g., through life insurance policies and/or installment payment plans).
Consistent Reminder of Succession Planning
I would guess that almost every business owner reading this article has a business succession plan in effect, likely created in the early years of their business creation. However, that is not sufficient. Every business owner should both understand its implications as well as confirm that it accomplishes the collective goals of the owners and the business. This requires the succession plan to be reconsidered on a regular basis (e.g., every year or two) and special care should be taken before any transfers of ownership are made. A good succession plan can make all the difference between long-term success and failure of the business.
Scott A. Breen is an attorney and shareholder at Willingham & Coté, P.C. in East Lansing, Michigan. Mr. Breen also has a Master of Laws degree (LL.M.) in taxation. He specializes in the areas of business and real estate transactions as well as hospitality and alcohol beverage law. Mr. Breen may be reached at 517-324-1021 or email@example.com.