By G. Timothy Leighton *

January 15, 2021 —  The previous “Better Way” column explored succession planning as an investment in the future for the enterprise, its owners, employees and even your customers or clients.  In order to preserve the value of the enterprise the business owner has created, it’s important to plan for the orderly transition of ownership.  This article covers some of the tools for that planning.

Starting With the End in Mind.  Business owners who ask themselves how they will preserve the value of the business for when they are no longer in business should keep their financial statements current, analyze them regularly both independently and with professional advisors, and arrange legal structures for their present and future positions. By anticipating their requirements, generating choices, making decisions and implementing them, they eliminate anxiety and enhance their chances for success.

There are legal tools, financial tools and others that blend these two areas. Careful communication among business partners, attorneys, accountants and other professionals can also make the difference between success and failure.

Legal Tools.  Entrepreneurs decide how to structure the enterprise to accomplish objectives such as tax treatment, continuity of the business, liability management and levels of complexity or simplicity. It is wise to rethink those decisions from time to time and consider whether the choice of entity (sole proprietor, partnership, LLC or corporation) still helps advance the goals. Should you continue operating your business in the present form, or would a change make sense?

Business owners should also consider the relationship between their personal and business financial situations. Have you reviewed your personal estate plan lately? How about employee ownership issues and gifting to relatives, friends, and key colleagues? Think through how your personal life, business operations and state/federal laws have changed. Work with your lawyer and accountant to figure out various options and the tax and control consequences of each choice regarding wealth transfer.

Related to these transfer issues is how the enterprise treats compensation of both owners and key employees. There are many techniques available for transferring income year to year. Again, assess these from the dual perspectives of control and tax impact.

Financial Tools.  In operating a business, it’s essential to review your financials from time to time to help compare where the business is now to where you want it to be. Owners rely on three specific financial statements for this ongoing assessment:  the balance sheet (reporting assets, liabilities and equity), the income statement or profit/loss statement (showing income, expenses, and net profit/loss) and a cash flow statement (managing that scarce resource in business operations and investment). Quality professional advice from an accountant helps interpret and understand how these various numbers relate to the enterprise so the owner can lead and adjust, rather than react.

For succession planning purposes, you use these same tools but determine what it is going to take for the owner to depart in a planned fashion, or what it is going to take for the next owner to buy the business if the change happens ahead of plan (for example, because of disability, incapacitation or premature death. The ultimate value of the financial statements depends on how accurately they reflect actual performance in order to rely on them for making future decisions.

As you consider the future, you must generate projections regarding internal challenges as well as what is going on in the marketplace, including competitors, suppliers and customers. Take care to incorporate historical trends, infusions of debt and/or equity, and other factors particularly relevant to your enterprise.

The last key financial piece is business valuation. Valuation experts should be engaged from time to time for formal analysis. Owners should also check with trade associations and industry journals for comparison data. Both the present owner and the likely future owners need to determine their respective objectives in order to negotiate mutually acceptable exit/entrance strategies.

Legal and Financial Combined.  The wildcard that allows for maximum control of the desired outcome is an effective buy-sell agreement. We all know we won’t live forever. We can anticipate exit strategies either on schedule or out of sequence. By planning for the options and negotiating mutually agreeable results before the pressure of a crisis, the entrepreneur can maximize wealth preservation and transfer success. Like the proverbial umbrella, it’s best to have it before the storm clouds gather. Be sure to engage a lawyer to help you with your buy-sell agreement.

To make the buy-sell effective, you must fund it. Pull together the pieces regarding financial and legal planning to determine costs involved for major alternatives. Then line up the appropriate financial instruments to achieve the desired control, tax and transfer results. Typical funding tools include life insurance, annuities and sinking funds, unless existing cash flow is sufficient to carry the ongoing enterprise as well as compensate the exiting owners or their heirs.

Attorneys and Accountants.  A knowledgeable attorney and business-oriented accountant are invaluable to a business owner. Attempting to run everything on your own without professional advice and assistance can be disastrous and can lead to the failure of your business. As tempting as it may be to save a little bit of money by avoiding attorneys and/or accountants, the money will be well-spent in the end.

Review and Adjust.  While you focus on day-to-day operations, once you have begun a plan for preserving the value you are building, be sure to review the plan from time to time. Internal and external factors challenge and offer opportunities. Keep tabs on others in similar and related enterprises. Pay attention to the news, including potential changes in taxes, liability management, and other relevant areas. At least once a year, if not more often, consider adjusting your plan to reflect your changing expectations and requirements. Seek feedback from your professional advisors and mentors. And enjoy the journey!

* Tim Leighton of Leighton Legal Group, LLC is an experienced lawyer based in Bloomington, Illinois who helps business Clients build their enterprises and plan for continuation after it is time to close the business or sell the business to someone else. Click here for ways to get in touch with Attorney Leighton.