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For some advisors its not worth their time to work out a succession plan In many cases succession planning is so difficult for advisors to successfully pull off because many people dont understand the work necessary and do not want to invest the time and money to do it properly Seivert says

Six Elements of a Successful Succession Plan

Talking business succession planning with Thomas Abendroth at Heckerling 2018.

Business succession is simultaneously one of the most fretted about and least properly planned for stage of many advisors’ businesses.

Despite a particularly unwieldy title, Business Succession: Abdicate? Affiliate? Alienate? Bifurcate? Syndicate? Liquidate? Vacilate? Don’t wait. Cogitate and Participate, Thomas W. Abendroth, a partner in the Chicago law firm of Schiff Hardin LLP, delivered—with a relaxed midwestern charm—excellent knowledge and practical advice on business succession during his presentation on the second day of the 52nd Annual Heckerling Institute on Estate Planning in Orlando, Florida. 

Abendroth defined business succession as “planning for the exit from a business in a cost- and tax-efficient manner which allows the business to be successful afterwards.” He then proceeded to identify and discuss six themes that are key elements to a successful succession plan. They are: (i) starting the planning as early as possible—even before the client has a clear idea for his exit plan; (ii) flexibility to allow for the exit plan to evolve or change; (iii) bifurcation of control and equity; (iii) diversification of planning techniques; (v) transfer tax savings; and (vi) non-tax factors, including maintaining family harmony when the exit plan has some family members exiting the business while others remain.

He discussed clients who may agree to transfer equity in a business to the next generation pursuant to a succession plan, but are loath to give up any control of their business. To address this issue, a change to the capital structure of the business is warranted. A business in corporate form will create a class of non-voting stock, a partnership creates limited partner interests and a limited liability corporation creates a class of non-voting member interests. The client retains the voting shares or interests and remains in control. The non-voting shares or interests, representing much of the equity value, is transferred to the next generation. 

This bifurcation of control and equity also generates valuation discounts for the non-controlling interest, which are understandably advantageous for estate planning transfers. Additionally, if the plan calls for all the children to have economic ownership of the business but for only some of the children to operate the business, the client can give voting stock or interests to the children who operate the business and non-voting stock or interests to the children who are passive.

When a client has succeeded in transferring the equity of the business to the children but still remains active in the business, it’s important for the client to take reasonable compensation for services. This protects against an IRS argument that the client is making indirect gifts of his services. Also of concern is the client guaranteeing loans to the business in which he no longer has significant equity. To avoid any IRS issues the business should pay a guarantee fee to the client.

The discussion of non-tax factors when the exit plan has some family members remaining with the family business and other family members exiting was particularly interesting. Succession plans often provide for exiting family members to receive compensating assets or cash of comparable value in exchange for exiting the business. The compensating assets may be a bequest or gift from the parent or pursuant to a buy-sell agreement. Problems arise when the exiting family members have unrealistic inflated expectations for the value of the business. Abendroth suggested hiring a business appraiser early on in the planning to educate all family members on proper business enterprise valuations, including valuation discounts.

Additionally, it is important to consider and possibly compensate the exiting family members for the less tangible ownership benefits that they’re foregoing, such as health insurance through the business, free samples of the company product or travel budgets. 

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