Succession Planning for Business Owners: Start Here

What happens to your business when you step away — or can’t return? In this episode of The Mark You Leave, the legal team at James River Law explains everything entrepreneurs and small business owners need to know about succession planning and preserving their business legacy.

🎯 Learn the fundamentals of:

·       What succession planning is and why it matters

·       Buy-sell agreements (cross-purchase vs. redemption)

·       Valuation methods for business exit

·       How succession planning fits into your estate plan

·       Real-world consequences of poor planning

Whether you're in a single-member LLC or a multi-partner corporation, this episode breaks down the tools, strategies, and common pitfalls business owners face when planning for the future.

📞 Need help with your succession plan? Schedule a consult at www.jamesriverlaw.com
💌 Submit questions: podcast@jamesriverlaw.com

#successionplanning #smallbusinesslaw #businesslegacy #buyandsellagreement #estateplanning #virginialaw #businessowners #entrepreneurlawyer

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• Website: jamesriverlaw.com
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Transcript

Tariq:

Welcome to the Mark You Leave, our podcast here at James River Law, where we discuss the entrepreneur's journey.

I am Tariq, and as always, I'm joined by Alex and Bri.

And today we're going to dive into succession planning.

Alex:

Very excited.

Tariq: 

Yeah, to get it started.

Nice, nice.

Tariq: 

We're feeling good.

Alex: 

I'm feeling great.

Let's get it.

Tariq: 

Cool.

To get us started, let's just start with a question that may seem basic to some, maybe more complicated to others.

What is succession planning?

Alex: 

So, succession planning is the process of identifying and preparing for and making plans for the next generation of owners of a business.

So, it's basically, how do you as a business owner, exit your business?

So, a lot of times we talk about getting businesses started or how to grow a business, but just as important as all those things is how you end up eventually leaving your business.

And the idea with succession planning is that it's a way of capturing all of the value and the hard work and sacrifice that you put into your business so that when certain events happen, that value is captured for you, for your family, and also just to preserve the legacy of your business.

Most of us business own owners want our family to benefit from this asset that can be very valuable.

Oftentimes the business is the business owner’s most valuable asset.

It's the thing that is worth the most in their estate.

And so that value can actually be lost if you don't plan successfully.

The other issue is that value can go to the wrong person if you don't plan successfully.

Bri: 

That was about to be my question.

Kind of why is it so important to put this in place?

Alex: 

Yeah, well, again, you know, as business owners and entrepreneurs, you are sacrificing a tremendous amount of time.

You are putting your heart and your soul into your business.

Oftentimes your family is sacrificing by allowing you to work as much as you do.

And you've just invested your blood, sweat, and tears into this business.

And so, without a succession plan, all of that hard work could really, in the very end, really go for naught.

If your business is not worth anything to your family when you leave it or if it just, you know, dissolves when you're gone.

So, succession planning is really a tool that allows you to make sure that your business will continue or that your family will get paid out.

And so, it is an incredibly important tool because if you don't think about the end in mind and something happens to you and there's an emergency, your family could really suffer some serious consequences for that business.

And we'll kind of talk a little bit more about that later.

Tariq: 

Yeah.

So, what succession planning itself is a tool, but what tools can be used to achieve succession planning?

Alex: 

So, there are different tools.

You know, a company, if you have an LLC, a company operating agreement can sort of address sort of succession planning or your bylaws if you're a corporation.

But the main tool that we use is what's called a buy-sell agreement.

And this is an agreement that owners of businesses use to determine what will happen to their equity in the business upon the occurrence of certain events of like death, disability, retirement, sometimes termination, if they just leave the company for one reason or not another.

And so, a buy-sell agreement, and there are different types of buy-sell agreements.

So, the most common two are, what are called, a cross-purchase buy-sell agreement where you have two owners or two or more owners, and they essentially agree in advance to purchase the other’s share if a certain event happens.

Then you have a redemption agreement where the company would agree to buy the departing owner’s shares.

And those are kind of like the two big species of buy-sell agreements that allow a departing owner to be paid for their share if something happens to them.

Tariq:

And is it similar if you're in a single member LLC or is there a different process for that?

Alex: 

Yeah, so that's a little bit of a different situation because, you know, when you have a partnership, it's really easy to kind of, you know, structure a buy-sell agreement because you have two partners. They want to buy each other out.

They're already working in the business.

When you have a single member LLC, it takes a little bit more thought. But you can do it, and you can use a buy-sell agreement.

It's called a one-way buy-sell agreement, where you basically are agreeing with a third party, typically a key employee who would be excited to sort of pick up the business and continue it on.

You agree in advance for them for certain events happen, they agree in advance to purchase it from you.

So, you can do a one- way buy-sell agreement.

There are other types of exit strategies where you eventually, you, sell your interest in your business to your employees through like an ESOP and there’s other programs like that, which we're not going to get into, but the primary tool would be a buy-sell agreement.

So, in terms of the just going to a little bit deeper into a buy-sell agreement, really it covers four sort of key areas within every buy-sell agreement.

The first is what are the triggering events?

We talked about death, disability, retirement.

It can also talk about termination but really sort of can define things like retirement, can define what disability means, define certain circumstances for termination.

So, it is really important to think through how you want that to look.

If there's a certain age, that you want to be tied to retirement, if you want disability to kick in after a certain period of time, all of those issues need to be sort of decided.

Death is kind of obvious.

But then the next thing that a buy-sell agreement deals with is valuation method of like how the actual price of that purchase is determined.

And typically, business owners will agree on a price in advance, and they will basically revisit that number every year.

So, there's there might be an exhibit to the buy-sell agreement that says, this is how much the business is currently worth .

And that number is sort of agreed upon on an annual basis to kind of keep in line with where the business is.

And that's a great way to do it because you can essentially lock in, you know, what that payment price would be without having to worry about, you know, the business, getting an appraisal that that might not be as favorable, which is the other way to do it, is to have to agree on a third-party appraisal.

And so, you basically say at the time of whatever the triggering event is, we're going to go out and get a third party to appraise the business, and that will determine the price.

Now, you have a little less control when you do that, and we have seen instances where the expectation is for that appraisal to be a lot higher, but then it comes in lower.

And so there is a little bit of a risk there with having the fair market value or an appraisal being the valuation method.

So, a lot of times business owners will just kind of agree on a price .

And the last is just what are the rights and the obligations of the remaining partner or the whoever is going to be purchasing the business.

So that's sort of a high-level overview of a buy-sell agreement.

And we are in the future going to spend some time talking more about buy-sell dynamics, because one of the most important things to talk about within a buy-sell is how do you pay for it?

You know, what is the funding mechanism for actually making this transaction happen?

And typically, that's through what's called buy-sell insurance, where you can take out a life insurance policy that it's either held by the company or each partner holds a life insurance policy on the other partner.

And that money is what actually ends up funding the sale.

And we have an upcoming guest who sells, by sell insurance and he's going to be able to kind of expand a lot more of the dynamics of how that works and some of the issues.

And so, we're excited to talk more about that later as well.

Bri: 

Now, I have a question because we talk a lot about estate planning and in general on this podcast.

So how does business succession planning for business owners connect to an estate plan?

Alex:

That is a great question, because estate planning and succession planning really do go hand in hand, and it's incredibly important that you handle both, that you don't just have an estate plan without a succession plan or that you have a succession plan without an estate plan.

And we've had instances where that's been the case where you may want the value to go to your family and you have your estate plan set up, but there's no mechanism for capturing that value through a buy-sell agreement.

Or more unfortunately, we've had situations where the succession plan has been done, but then the estate plan hasn't been done.

And we had a client.

We had clients who were had a, you know, this is just by way of an example, clients that owned a successful service business, as partners.

They were 50-50 partners, and they had their buy-sell agreement set up.

They had their buy-sell insurance set up.

Everything was perfectly set up.

But one of the partners hadn't done his Will yet.

He hadn't done an estate plan yet.

And he was in a second marriage.

He had adult children from a previous marriage.

And that business was started during his second marriage.

And his partner knew that the intention was for the other partner's wife to get all of the proceeds of the life insurance policy from the buy-sell agreement.

But here under Virginia law, if you die without a will, then you are subject to the state intestacy laws.

And so, you don't get to determine where your stuff goes.

And so, unfortunately, one of the partners who had a second marriage passed away in sort of a freak accident .

And because he hadn't done a Will, his wife was only able to, under the Virginia intestacy laws, she was only entitled to one third.

And so, on a million-dollar buyout, you know, where she was supposed to get a million dollars, she was only able to get $300,000.

And so, and his adult children got the other two-thirds.

And so that was a hugely impactful consequence of not getting your estate plan done.

And we were there was really nothing that we could do because it was sort of out of our hands and because he hadn't done in an estate plan.

So, it's incredibly important that if you are working on your succession plan, that you take that next step and make sure that you're estate plan aligns so those funds can go where they ought to go.

Tariq: 

So that point, though, how often should you be updating this?

Alex: 

Yeah, so that's a good question.

I mean, I think that, you know, in general, we kind of recommend that you look at your estate plan every, you know, three to five years.

I think with your succession plan, I would say that's a good, you know, mark as well every three to five years.

But again, some business owners are looking at every year and they're kind of looking at where their business is, as certainly in terms of updating the number.

But also, if you're business has any type of material change.

Like if you bring on a new partner, if you expand, if you contract, whenever there's a major event within your business, it's a good idea to take a look at your succession plan and make sure that it aligns with where your business is.

So again, I think that was a good kind of good stopping place for talking about succession plans.

But again, really the “why” behind this is that you want to make sure that all of the hard work, all of the energy, all of the sacrifice, is not lost because you haven't made a plan, because oftentimes, if you're a business owner, you're driving the revenue.

So, if you're not there anymore, a lot of times your business loses a lot of value.

And so that would make it really difficult for your family to maybe monetize your interest for the same level that they would if you were alive.

And a succession plan allows you to do that.

The other thing that we didn't really talk as much about is just where the business is left without a succession plan, because you might leave your interest to a spouse or to a child and they might not want to be a part of your business.

They might not know how to do your business.

Also, if you have a partner, your partner might not want to be in business with your spouse or with your child.

And so it really is important to think about how you, how to begin with the ending in mind and to really make sure that everything is set up so that you're honoring your business partner, you're honoring your family, and that no matter what happens, you're capturing all of that hard work, and energy that you put into your business.

If you have questions about succession planning, if you're a business owner, if this is something that you've been wondering about doing, we would love to hear from you.

We do offer, you know, consultations.

But also, if you have a question that you want us to answer on the podcast, just write to us podcast@jamesriverlaw.com, and we would be happy to sort of answer, um, any of your questions in a future episode.

Tariq:

And be sure to follow us on socials.

@jamesriverlaw on Facebook, Twitter, Instagram, check out our website, Jamesriverlaw.com, and we will see you in the next episode!