How to Succeed at Succession
The importance of creating a plan to keep a business going for generations
on June 30, 2021
Updated on April 18, 2022
About 20 years ago, attorney Charles Turnbull sat watching the clock during what was supposed to be a meeting to firm up a buy-sell agreement as part of a client’s succession plan. The client had been pressing a partner to finish the paperwork and it was finally supposed to happen. But the partner never showed up. “He was in an accident on a local freeway in Detroit, coming here to the office to sign,” says Turnbull, who focuses on business and estate planning at O’Reilly Rancilio in Sterling Heights, Michigan. “And he was killed.”
Such a tragic twist is rare, but it highlights the importance of having a written plan of succession. It’s essentially an estate plan for your business—to keep it operating if something unexpected happens to you, or when you retire. According to a survey by the National Bureau of Economic Research’s Family Business Alliance, family-owned businesses account for 60% of jobs in America, yet only 15% have any kind of succession plan in place.
“Virtually every business owner that I’ve represented, in their head, has an idea of how the business will grow and then transition to either a sale or to the next generation, and how the employees will be treated,” says Turnbull. “But they don’t always get it put in the form of a written plan.” The most common reason to procrastinate, says Julie Pleshivoy, who practices estate planning & probate and business law at Taft Stettinius & Hollister in Chicago, is to avoid an uncomfortable truth. “The idea that the business will continue without the founding family member is a painful concept to bear, as it reminds people of their mortality,” she says. “It has everything to do with this emotional connection to your business as part of yourself and a failure to face your own fears.”
Anthony Vecino, an estate planning & probate attorney at San Francisco’s Farella Braun + Martel, points out that some simply don’t grasp how critical a succession plan really is. “I’m consistently amazed at how hard people will work to achieve those [business] goals, and yet neglect the future and fail to provide an adequate plan for the continuation of the business.” Granted, attorneys did experience an uptick in calls during the pandemic. “I think the pandemic has caused a sort of heightened awareness among everyone that we are all mortal,” says Scott Squillace, an estate, business and tax attorney at Squillace & Associates in Boston. “Most people think, ‘I will get to that later. My grandparents lived until this age, and I eat less red meat, so I don’t need to do it now.’ But those people have become more conscious of the fact that crazy things can happen prematurely.”
Even sole proprietors, such as artists and writers, and tech entrepreneurs with privately held ventures designed to go public, while they may not need a full succession plan, need to leave behind instructions on how to pay the final bills and taxes. And, says Pleshivoy, “A solo dentist may think that there is nothing to plan. However, without the solo dentist to take care of the business matters as well as the patients, how will the business continue to run or wind down?”
Best-Laid Plans: Successful Succession Planning
A business succession plan isn’t just one legal document, but several that complement the owner’s personal estate wishes with wording that covers everything from buy-sell agreements and employee compensation to hiring and, of course, deciding who’ll be in charge.
A good place to start is with an organizational chart that outlines the role of key positions and employees. Make sure the company is in a trust, attorneys say, and pick a successor trustee whose judgment you value. Get buy-in from your designated successors.
“The ones who work collaboratively stand the best chance of success, because everybody’s around the table to hear things in real time, to have a voice, and to really structure it in a way that works for everybody, versus a death-time scenario when there’s typically an upwelling of long-suppressed sibling rivalry and dysfunction that comes to the surface,” says Vecino.
Leaving your business to your adult children may seem like the logical choice, but it isn’t always that simple. If one is more qualified than the others—has more business competencies or has spent more time with the company—consider giving that person the leadership role and the rest voting rights on the board of directors. Test the waters by gradually making the transition, Turnbull says. “I have a client now where the first step was to bring his son and daughter on board as officers. They worked there for him, then he brought them into the decision-making process, put them on the board and eventually moved stock to them. Take a step at a time and see how the next generation responds to it. It doesn’t have to all be done overnight, and it doesn’t have to be done the same for each child.”
Sometimes a potential successor doesn’t want to remain in the family business. Avi Kestenbaum, a tax and trust and estates attorney at Meltzer, Lippe, Goldstein & Breitstone in Mineola, New York, gives the example of a single mother who leaves her company to her only child. “The daughter can sell the business, can continue to have the key employees run it, can bring in a new management team, can try to be involved part-time,” he says. “But from Mom’s perspective, if she knew her child wasn’t interested, maybe she would’ve sold the business and gotten more money while she was alive.”
If the business owner has no heirs, designating a long-time employee to take over—“typically someone who’s been around for a decade or two,” says Pleshivoy—might make the most sense.
Creating a succession plan on your own is risky. “There are all sorts of land mines out there that you can inadvertently trip,” Squillace says, “and it can wind up costing the family a lot more in the long run.”
Pleshivoy has helped many clients pick up the pieces after the land mines. “Even for the smallest of my clients, we have had tens of thousands in litigation expenses because things were not done appropriately. There’s a lot of litigation based on incomplete documents.”
In addition to an attorney who understands tax laws in your state and can navigate sensitive family issues, you’ll need a good accountant and perhaps a business coach or financial adviser. Ask other business owners for referrals and interview several lawyers to find the right fit. Take time to align your personal and business legacies. If your power of attorney specifies that your spouse step into your shoes if you’re incapacitated, but your business agreement names your partner as the one to vote your shares, you’re putting both of them in an impossible position.
“People think, ‘My spouse has my power of attorney, so they can do everything,’” Squillace says. “Well, the power of attorney for personal things is different than the power of attorney for business things, and the power of attorney for personal stuff doesn’t always work for processing payroll and accessing bank accounts and paying taxes for the business.”
Setting up a succession plan is neither quick nor cheap. Pleshivoy estimates that most cost between $10,000 and $20,000. Some are much more.
“This is not an item that should be rushed,” says Kestenbaum. “We’re dealing with the most sacred treasures of our clients: their children, their grandchildren and their business. Each of them are legacies.”
You can, however, save money by asking your attorney what you can do to streamline the process. And bringing good records to your meetings, says Vecino, equals “immediate dollars that are back in the client’s pocket.”
Retention and Avoiding the Worst-Case Scenario
Without a proper succession plan, a host of problems can result.
Jessica Wood, a business litigator with Bodker, Ramsey, Andrews, Winograd & Wildstein in Atlanta, once represented a hairstylist whose business partner died unexpectedly. “All of a sudden, her husband, who our client barely knew, calls her up and is like, ‘Howdy, partner.’ … [His wife] didn’t have a will. There were no documents to govern how anything was supposed to happen. In that circumstance, if we had a piece of paper, we could have said, ‘Sir, here’s what it says in paragraph three.’”
Even worse is the war that can occur when relatives pull in different directions, paralyzing both the business and family dynamics. It can also mean real economic losses. “We had one litigation case where we were in seven figures after a year. That’s a lot of money to lose on fighting with your family,” Pleshivoy says.
But when it comes to working on a succession plan, it’s never too late, says Turnbull. “I’ve had people come in who are either terminally ill, or immediately before selling a business. We can do some very quick steps that help the transition along that, ideally, would’ve been implemented perhaps a year or two or three prior. But you can still do some catching up.”
Even if your plan isn’t perfect, something is better than nothing. For the past decade, Kestenbaum has been working on estate and business planning for one overly cautious client worried about doing the right thing by his business, employees and children.
The documents, which are more than 70% finished, will be improved upon over time. “It’s the concept that Rome wasn’t built in a day, but we’ve got to start somewhere,” he says.
On the flip side, one of Kestenbaum’s clients kept hedging out of concern that one child would overpower the others after he was gone. “We were getting closer to getting the documents signed and he’s like, ‘Just wait another week.’ He died from COVID-19 after spending a year and a ton of time and money. And he had nothing [in place] when he died.”
The term “business prenup” may be new, but the concept isn’t. Part of a succession plan for a business with two or more partners or shareholders—and often part of a buy-sell agreement—it resembles a matrimonial prenuptial contract that divides assets in the event of a “divorce.”
Any life transition can trigger a split, Wood notes. “Someone has health issues, someone wants to retire or step down or work less hours. Or you think someone is vacuuming money out of the corporate account or your entity just got a PPP loan for $200,000 and it disappears.”
Not surprisingly, many small-business owners skirt around such agreements until it’s too late. “People go in with optimism,” Kestenbaum says. “They don’t want to deal with the issue, which is the same reason many people do not do [marital] prenups. It’s not that they’re unaware that a divorce can happen. They don’t want to deal with the confrontation. They don’t want to upset the other person. I think it’s less about not realizing it and more about kicking the can down the road and not wanting to have a fight when things are good.”
As a precaution, new partners should hire separate attorneys to draw up the agreement. Include an arbitration provision to help keep you out of court, and don’t take anything for granted. Squillace recalls a case where one partner stepped down, assuming his co-owner would continue to pay off their co-signed loan, only to discover he was still liable. The bank came after both of them.
Just as with general succession plans, lack of a prenup can lead to some pretty nasty consequences. “I’ve seen partners who were childhood best friends at each other’s throats, not speaking with each other, despising each other, in court for years thinking the other person is evil,” Kestenbaum says.
And whether you’re drawing up a succession plan or a business prenup, review the documents periodically. “It’s not a static thing,” Vecino says. “The evolution of a business is a fluid situation, and I think the owners really need to constantly have their antennae up as to what could go wrong and how to address it.”