Succession Planning for the Closely Held Company

When it’s time for you to retire or sell your business, what will happen to your company? As a business owner, you should be able to answer this question. However, with the daily challenges of maintaining positive cash flow and ensuring smooth operations, it’s not uncommon for a company to lack a succession plan. If your company doesn’t have a written succession plan, read below for the basics of creating and updating a plan for your company.

What is a succession plan?
A succession plan is a document that spells out how a company will be owned and run if the current owner/leader retires or is no longer able to participate in the company’s operation.

What should a succession plan include?
First, a well-thought-out succession plan should define the owner’s retirement or the owner’s desires regarding a sale of the company. As an owner, do you plan to appoint your child or another relative as successor? Or do you plan to sell the business? If planning to sell the company, do you want to sell it to employees in an employee stock purchase plan, or will you look for an outside buyer?

Secondly, much like a personal will, a succession plan should spell out a contingency plan for emergency succession, allowing for an orderly transfer of leadership and business continuity in the case of unforeseen circumstances.

What are some key considerations when preparing to sell your business to employees?
1. Make sure that the company’s valuation is current. If the intent is to have key employees purchase the company, a business valuation, which estimates the value of the company, should be initiated and then updated each year. Your banker can provide you a list of references for companies who can value your business.

2. Keep your company’s Operating Agreement up to date, and provide the process and terms for the company’s succession plan in that document. Operating Agreements are extremely important in spelling out the terms of an employee stock purchase plan, providing parameters and pricing around stock redemption and purchase by the company, and in identifying possible distributions. The importance of timing for employee stock purchases and the requirements in terms of tenure with the company for both eligibility and redemption are important issues that need to be clearly spelled out in this document.

3. Create or update a separate Employee Stock Purchase Plan document that sets forth the parameters and limitations of such purchases and redemptions. Outstanding performance and substantial contributions to the company’s success should be the standards by which employees qualify for a purchase. Tenure with the company should be the standard for sale of stock back to the company by such employees. 

4. The employee plan above must fit with the owner/CEO’s objectives with regard to tax and estate planning. There should also be a mechanism for the company’s repurchase of his/her stock.

5. Lastly, employees should have some skin in the game - that is, they should be provided the opportunity to place some of their financial wealth on the line to purchase the company stock. There may be several options available to them. They may be able to purchase the stock outright for cash or alternatively, qualify for a loan to purchase this stock by providing the bank with appropriate collateral. More often than not, the company’s primary bank may have to provide financing and place the proceeds in a collateral account or require that the company provide a guarantee or collateral for these loans.  

Who should be involved in the succession plan?
Succession planning should involve not only the company’s owner/CEO, but also the company’s Chief Financial Officer, attorney, accountant and banker to ensure that the plan is well-understood and carried out at the appropriate time.

To ensure well-planned succession, it is essential that careful planning be undertaken to maintain the company’s long-term stability and success. I have found that the bank relationship manager can play a key role in this planning process and offer valuable insight and advice, as they often have a personal relationship with the owner and have been involved in the company’s financial operations.

If you would like to talk more about your company’s succession plan, send us an inquiry today.

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Maura A. McKenna, Senior Vice President, Corporate Banking
May 21, 2012