Why You Need to Consider Succession at Formation of a Business

Many entrepreneurs and new business owners start out their venture with a passion, eager to build upon their vision and put in the work necessary to grow their business into a success. These business owners often focus on the initial important steps of getting the business off the ground and in doing so many overlook the important aspect of business ownership: the succession plan.

Every business owner should set aside time and give consideration to the manner in which they will exit and/or what they intend for the business once they are gone. This process is known as succession planning.

Succession planning is the development of strategies and rules to pass an organization to the next group of owners and/or managers, whether they be family members, employees, or third-party purchasers.

Succession planning may address both aspirational objectives (e.g., passing business to your children) and unwanted but foreseeable circumstances (e.g., death of an owner). The business succession plan is an important aspect of any business plan and it should be given ample consideration throughout the life of the business as goals, expectations, and motivations change.

Even at the formation stage, business owners should be cognizant of their succession plan. One of the first decisions a new business must make is determining its entity formation. This decision will have a lasting impact on the business dictating the governance structure, status of owners, tax liability, and the likely succession procedures. Owners will adopt entity governing documents establishing the legal framework by which the entity will be governed. Amongst the many important items addressed within the governing documents includes the admission of new owners, transfer of ownership interest both voluntary and involuntary, procedures for selling the business, and a framework for purchase price valuation. Agreeing to these items at the outset of the business sets a clear framework for addressing these issues when they arise helping avoid potential future conflict.

In addition to the entity governing documents, businesses may also choose to have its owners enter into a buy-sell agreement whereby the framework for any potential transfer amongst owners is set forth in contract. These agreements establish the rights of a business owner to sell their interest in the business and the obligation by which that interest must be sold. Buy-Sell agreements can be used for multiple different scenarios including an owners death or incapacitation, a breakup amongst the ownership group, or simply an owners desire to exit the company.

No matter the reason, a buy-sell memorializes the legal framework by which an ownership interest will be transferred when certain triggering events occur. These agreements typically involve a sale back to the business entity or an offer to business partners prior to the interest being sold to a third party. Sometimes, a buy sell may account for an owners estate or children also being afforded the opportunity to purchase the interest. Additionally, the buy-sell agreement generally sets forth methods for determining a fair market price for the ownership interest. There are many ways this price can be determined and business owners should consider amongst themselves and consult with an attorney or accountant when determining which valuation method is best for their business.

There are many ways in which business owners can adequately protect themselves and their entity through proper planning at the outset of the agreement. Whether it be through properly drafted entity documents, comprehensive buy-sell agreements, a combination of the two, or multiple other options to maximize tax and control interests new business owners should give amply consideration to what they want the succession of their business to look like and what they want their exit strategy to be. The succession plan is an important piece of the business plan and an integral part throughout the life of a business and it should not be overlooked from the beginning of the business until it is time to implement the succession plan and pass off ownership.