Growing a successful business, purchasing investment property, and building wealth often requires decades of careful planning and disciplined decision-making. Eventually, however, you will reach another equally important phase of that journey which involves determining what will happen when it is time to step away. Whether that happens because of incapacity, retirement, or death, a carefully designed exit strategy is crucial to a successful and orderly transition that protects your interests and provides for surviving loved ones. By incorporating exit planning into your California estate plan, you can preserve the value of everything you have built while making the transition as smooth as possible for those you leave behind. Toward that end, the Los Angeles at Schomer Estate & Wealth Advisors discuss exit planning in your California estate plan.
What Is Exit Planning?
Exit planning is the process of preparing for the eventual transfer of your assets, responsibilities, and decision-making authority. While the concept often focuses on the sale or succession of a closely held business, effective exit planning extends well beyond business ownership. In practical terms, your exit plan serves as a roadmap that addresses questions such as:
- Who will manage your financial affairs if you become incapacitated?
- Who will inherit your property?
- How will your business continue after your retirement or death?
- Who will make medical decisions if you cannot?
- How will your family access the financial resources they need?
- What steps can reduce taxes, probate costs, and family conflict?
Why Is Exit Planning an Important Part of Estate Planning?
If you are like many entrepreneurs, your business represents your largest financial asset. Although your home, retirement accounts, and investment portfolio may have significant value, the value of your ownership interest in the business may exceed all other assets combined. If so, your family may be dependent on business income after your death or incapacity while the business itself may face substantial tax obligations. In addition, transferring ownership without disrupting operations requires careful legal planning. These unique concerns prevent you from treating your business like most other assets within your estate plan. Instead, you need a well planned out exit strategy within a comprehensive estate plan.
Begin with Clear Exit Planning Goals
Clarifying your goals and objectives before proceeding is essential to creating a successful plan. While some business owners hope their children will continue operating the company, others want management employees to purchase the business over time. Your plans may include selling to an outside buyer or transferring ownership to an existing partner. To help you clarify your goals, consider the following questions:
- Who should ultimately own the business?
- Who has the ability to manage daily operations?
- Will family members actively participate in management?
- Will inactive children inherit business interests or receive other assets?
- When do you hope to retire?
- What income will you need after leaving the business?
- What happens if disability forces an earlier transition?
Choosing the Right Successor
Selecting a successor involves much more than determining who receives ownership because the individual(s) best suited to manage a successful business may not necessarily be the same person that you want to benefit financially from the business. While you may want your spouse and/or surviving children to receive a financial benefit from the business, leadership requires experience, financial knowledge, industry expertise, and the confidence of employees, customers, vendors, and lenders. As such, knowing who your beneficiaries are is not the same as knowing who your successor is.
Moreover, leaving a family business to your children can create its own potential issues, particularly if you start with the presumption that all children should inherit equal ownership interests. Although equal treatment sounds fair, equal ownership does not always produce equal results. By way of illustration, imagine that you have three adult children, but only one child has spent twenty years managing operations within your business, while the others pursued unrelated careers. Giving each child equal voting authority may create disagreements over all facets of the business operation. To avoid these disagreements, you may prefer to create an estate plan that distributes business ownership unequally while using other assets, such as life insurance, investment accounts, retirement assets, or real estate, to balance the inheritances passed down to all beneficiaries.
Business Succession Planning for Family-Owned Businesses
If your plan is to pass your business down to future generations, an effective succession plan may gradually increase the next generation’s management responsibilities before legal ownership transfers to them. This allows future leaders to gain practical experience while customers and employees develop confidence in their leadership. A gradual transition produces a smoother transition than waiting until retirement or death to determine who assumes control.
In addition, you may wish to consider using a revocable living trust to help transfer business interests while also avoiding probate for assets held in the trust. Your designated successor Trustee can often assume management responsibilities immediately after your death according to the terms of the trust document. Moreover, ownership interests can remain in trust for beneficiaries rather than transferring outright, a particularly beneficial option when beneficiaries are young adults, struggling with mental health issues or addiction, or subject to creditor claims.
Planning for an Unexpected Incapacity
Many business owners focus exclusively on what happens after death while overlooking the possibility of incapacity. A serious illness, stroke, accident, or progressive cognitive condition, however, may prevent you from managing your business long before your existing estate plan becomes effective. Without proper planning, financial institutions, vendors, and employees may have no legal authority to continue normal operations.
To successfully plan for the possibility of incapacity, your estate plan should include a Durable Power of Attorney authorizing a trusted individual to handle financial matters if you become incapacitated. Depending upon the structure of your business, additional corporate documents may authorize managers, officers, directors, or partners to continue operating the business during your incapacity.
Coordinating Buy-Sell Agreements with Your Estate Plan
If you do not plan to pass your business directly down to family members, you may wish to consider using a buy-sell agreement to govern ownership transfers upon your death, disability or retirement. A buy-sell agreement can be used to provide other existing owners (or a third-party) with the right or obligation to purchase your interest in the business according to predetermined valuation methods.
Business Valuation Matters
Unfortunately, many owners substantially overestimate or underestimate the value of their companies, which makes an accurate business valuation crucial to successful exit planning. Knowing your business’s current value helps you make informed decisions regarding retirement planning, life insurance needs, succession planning, and wealth transfer strategies. Emotional attachment, changing market conditions, and inconsistent financial records can produce unrealistic expectations. A professional valuation, however, will consider numerous factors, including:
- Revenue
- Cash flow
- Profitability
- Assets
- Liabilities
- Industry conditions
- Customer concentration
- Market competition
- Intellectual property
- Goodwill
Tax Considerations in Business Exit Planning
Although California does not impose a state estate tax, federal estate tax laws may affect larger estates. As such, business succession planning should also account for potential capital gains taxes, gift tax considerations, and income tax consequences associated with various transfer strategies. The use of lifetime gifting, family limited entities, and trust planning may help shelter your estate from any unwanted tax obligations associated with your business. Each strategy carries unique legal and tax implications but planning well before retirement or death offers more flexibility than attempting to implement these strategies during a crisis.
Communicating Your Exit Plan
One of the most overlooked aspects of a successful business exit plan is communicating the plan to the people it will impact. Family members may assume they understand your intentions, but those assumptions may differ significantly from reality. Although you are not obligated to disclose every detail of your estate plan, discussing major succession decisions with key stakeholders often reduces future misunderstandings.
Do You Have Questions about Business Exit Planning in Your California Estate Plan?
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about incorporating business exit planning into your California estate plan, contact the experienced Los Angeles estate planning attorneys at Schomer Estate & Wealth Advisors by calling (310) 337-7696 to schedule an appointment.
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