As published in Lancaster edition of Business2Business, August 2014 issue.

In working with business owners, we find that there is confusion about the meaning of terms which leads to a confusion about how to act. Here is our guide to clarify meaning so as to promote a more thoughtful path of action.

All businesses above a certain size threshold should be concerned with succession planning at several levels of the organization. What are we to do in the event that our sales manager becomes disabled, or more likely, finds a better opportunity and leaves us? Our shop foreman is 2 years from retirement, what are we doing to make sure that there will be a smooth transition to his replacement? This concern will extend up to the top levels in the firm. Say we have a $20 million company with 80 employees and 3 equal owners aged 60, 55, and 50. Each of the owners has a key management role in the business. If the older owner plans on retiring in 5 years, the younger owners (as well as other management team members) will be concerned that the company has a plan to replace her skills in the company quite apart from the issue of redeeming her stock. The perspective here is to protect the company and insure that it continues to run smoothly. All businesses should be doing this planning, but it is a haphazard affair for many firms.

Succession planning has a significant legal component. In the examples above, it is critical that the sales manager and shop foreman have non-compete and non-disclosure agreements. We don’t want the sales manager to leave and take customers with him to a competitor. Similarly, we don’t want the shop foreman to take employees or proprietary manufacturing methods to a competitor. In the case of owners, they should have a well thought out shareholders’ agreement that will place appropriate restrictions on the transfer of the stock and establish a mechanism for buying out retiring owners. We continue to come across instances in which these basic legal precautions have not been taken. For example, we are working with a 30-person professional services firm in which the senior professionals, but not the junior ones, have non-compete agreements. At the time that the owner is looking to sell the firm, 2 of the junior professionals have decided that they will leave and start their own firm and will likely take some clients with them. This is certainly inconvenient for the owner.

The sole owner of a business has a different perspective in planning his exit. The following issues present themselves: what will his personal financial situation be after retirement—can his personal assets together with the proceeds from the sale of his business provide adequate means of support? What is the business worth? Who is the best buyer—an outside company, perhaps a competitor, or key employees? What does he need to do to protect the business while planning his exit? When will he exit? What will the business owner do after separation from the business? To what extent does the owner need to continue to work in the business after the sale in order to maintain value? This last question shows the intersection of exit planning and succession planning. An owner exiting his or her business must be concerned that the business can thrive without the departing owner; otherwise the business will have very little value to any buyer—3rd party or insider. Similarly, in the example discussed above of the business owned by 3 equal partners, the departing owner will most likely be dependent on the future cash flow of the business to redeem her stock over time. Therefore, she is concerned that adequate provision be made to replace her in the business so that the company continues to be profitable. So this aspect of succession planning—replacing key employees—properly becomes part of the exit planning perspective of the departing owner.

Finally, estate planning is the concern only of the individual business owner. Provisions must be made for the disposition of all of the business owner’s assets including any business interests. However, a properly constituted exit plan must consider estate planning objectives. For example, if an owner is planning to sell his business to a third-party in 3–5 years, it might be appropriate to transfer non-controlling business interests to children to take advantage of valuation discounts to minimize overall gift and estate taxes (warning—consult your tax advisor). Similarly, if an owner intends to transfer a business to a child and also has significant charitable interests, it might be appropriate to put a portion of the business into a Charitable Lead Trust to minimize gift tax while at the same time accomplishing charitable objectives. Exiting a business provides an excellent opportunity to engage in estate planning transactions to help accomplish the business owner’s financial and personal goals.

Succession planning, exit planning, and estate planning all overlap but each has a separate focus. Succession planning is primarily focused on the continued strength of the business; exit planning on how the business owner will leave the business and his personal situation after the exit; estate planning on the disposition of assets during life and at death. Exit planning is the most comprehensive approach for the business owner because it requires a full consideration of both succession planning and estate planning in order for the owner to achieve her personal objectives.