Family Business Succession Planning

In 2016, a Family Business Survey by the National Bureau of Economic Research Family Business Alliance found that 43% of family-owned businesses don’t have a succession plan in place! When we consider the amount of planning, time, effort, risks and sacrifices it takes to develop a successful business, it goes without saying that it is mutually beneficial to all owners’ that there is a succession plan in place. This is even more important when considering family business succession planning. For many, family businesses are more than tools for wealth generation, they are a legacy to be  passed on. Unlike the mortal humans that come together to form family businesses, the business entity itself has the potential to be immortal, passing on the symbol of hard work and wealth from generation to generation.

The mortality of a family owned business depends on a successful succession plan. Family members who establish and operate their business, spend many hours ensuring that things operate according to plan – allocating additional time and resources to planning for triggering events such as another family member owner becoming disabled or passing, seems to be something that can be put on the back-burner. I mean the other controlling partners or co-owners are most likely brothers, sisters, parents or uncles right? So why should they concern themselves with what happens if one of them passes or becomes disabled? This thought process is understandable and is precisely why half of family-owned businesses do not have a succession plan in place; But when you delve into things a little deeper, you realize that it comes down to the fact that no one is truly educating the family businesses on the importance of succession planning and what’s truly at stake!

The truth is, there are many variables a family business needs to consider when it comes to succession planning. For instance, one may assume that if your brother who owns a controlling part of the business passes, everyone in the family business will come together and figure things out… but most of the time it is not that simple! For example, one of the family owners may get along just fine with a co-owner’s spouse, which may very well be an in-law, but would this owner be OK with becoming business partners with the spouse? Without a succession plan in place, if one of the co-owners passes then his/her business ownership will be passed to the deceased co-owner’s estate. This means that the new partner will be the beneficiaries of the estate, which most likely will include the spouse and possibly the children or step-children of the deceased owner. If the deceased owner did not leave many assets or life insurance proceeds for the family, then the spouse and other inheritors of the estate may rely on the business income and feel obligated to jump right in.

Even if the beneficiaries of the deceased owner’s estate decided on selling the business ownership back to the other co-owners, there may be issues when valuing it: Issues that can lead to expensive legal proceedings. Furthermore, when considering the possibility that relationships may not be as tight with the spouse or other beneficiaries and the co-owners that remain, matters are only further complicated. It is much better to have business values and plans set up before an event like this occurs. Buy/Sell agreements with life insurance funded with life insurance can solve these issues and create a ready market for the business or business owners to buy the deceased owner’s business interest from the estate at a value that is determined before a triggering event such as death of an owner occurs. This is in the best interest of all owner’s and owner family members involved!

This is where we at East Coast Financial can help! We hope that the business owners who are lacking in the succession planning department find success through our communications and eventually through working with us! In a 2019 Forbes article, it is stated by David Neubert, managing director of SunTrust Business Transition Advisory Group, “Generally, most family business owners find themselves so involved in the day-to-day operations, they’re not thinking of what’s next for them personally or for their family and how that intersects with the business.”

It is not only a lack of education...
This statement sheds some light on the fact that it is not only a lack of education, but a failure on the part of advisors and succession planning specialists, in educating family-owned business owners on the importance of succession planning. Today, this changes! Mark our words: we will do everything within our power to not only educate but to facilitate the implementation of key steps in succession planning for the half of family-owned businesses with risk exposure.
It took a lot of planning, communication and strategic execution for family-owned business owners to take their idea to a tangible, living and profitable enterprise. Unfortunately, these same owners are lacking in the planning, communication and strategic execution required to ensure contingency plans are in place for risks that can destroy a business’s continuity. Without a succession plan in place that covers the many aspects of ‘what happens’ if certain triggering events occur. Furthermore, without a succession plan in place families can find themselves in disagreements and legal turmoil, that can not only destroy the business but their family relationships too!
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Family Business Succession Planning
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It's never too late to start succession planning!
One common thread that we find not only with succession planning, but also in general financial and retirement planning, is individuals and business owners’ think it is more prudent to wait until ‘later’ to start planning. We constantly hear the objection “I am not quite there yet to start planning”. You wouldn’t get quoted on homeowners’ insurance after an electrical fire sweeps through your living room, right? Well the fire hat can wipe out your family and family business are just a dangerous and needs to be insured all the same!

For example, as a business owner with one or more children that you expect to take over your business eventually, it is never too early to start planning. The general rule of thumb is to start succession planning at least 10 years before such a transition. Some of the things that you will have to deal with as part of succession planning are estate planning, taxes, liability, ownership stakes and voting rights.

Successor Children Explained...
A very important aspect of succession planning is legacy planning. It is important to plan for how many children are involved in the business and which child or children will inherit the business. It is also important to determine which of these children will be active in business operations and to what degree. Planning for this can be very emotional and not only have an impact on the long-term image of the business and the financials off the business but will also have potential impacts on the family and the community.

In the past-times, it was assumed that successor children would take over businesses and little questions were asked. Fast forward to modern times, and children are more apt to proceed on their own independent trajectory – with progressively fewer succeeding generations being interested in taking over family businesses. According to PwC’s 2016 survey of family businesses, of those expecting to change ownership in the next five years, only 52% of them plan to keep the ventures in the family, down from 74% in its 2014 survey and the lowest number since 2010.

This trend adds to the importance and the complexity of succession planning well in advanced. It is important to remember that succession planning is never static and like with any form of planning, it is a constantly evolving process.

Whether you are a law firm, a services business with key salespeople, a medical practice, a financial advisory firm, or any other type of business, you most likely have key person employees. Take a second to think of these employees…Now, imagine if tomorrow one or all of them could not come to work for 6 months, 6 years or possibly never again? How would your firm be affected? If the negative effects give you even the slightest anxiety, you should consider a buy sell disability insurance policy to cover these key person employees!
One-way Buy-sell Agreement Solution

When considering solely owned businesses where an owner has the succession planning needs of children and a spouse to consider, having a plan in place to take care of both is important. There are many forms of buy-sell agreements, but the one that is best at accomplishing this goal is a one-way buy-sell agreement.

The business owner would start by having their lawyer or estate planning attorney draft a document. We understand that some business owners have smaller and more humble enterprises and may not have established estate planning attorney relationships. Besides helping our clients decide on and implement a funding strategy for their buy-sell agreements, we have a network of affordable estate planning attorney’s in most of the 50 states through the US.

The children mentioned above are normally adult children. After the business owner’s attorney drafts a unilateral one-way buy-sell agreement for these adult children to purchase the deceased owner’s shares from his/her estate, a funding source must be established. The best funding strategy will be for the business owner will establish a life insurance policy on his/her life with the adult child or children as the beneficial owners. It will be prudent for the business owner to have the business appraised and for the owner to determine the most reasonable price of the enterprise to be included in the buy-sell agreement documentation. This is the value that will be used to establish the face amount or death benefit of the life insurance policy.

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Let’s look at a one-way buy-sell case design example funded by life insurance

Assume we have Joe who is age 60 and owns an S Corp valued at $3 million per a third-party valuation that was recently completed. This business is part of Joe’s gross estate of $5 million. Joe is married to Mary age 57, who relies on the income from this business to continue their (and in turn her) accustomed lifestyle. Mary and Joe have two adult children Michael 34 and David 32, who have worked for the family business for many years.

Joe executes a unilateral buy-sell agreement with Michael and David, in which both Michael and David agree to buy their father’s S Corp ownership shares for $3 million from his estate at death. Michael and David are listed as equal beneficiaries of a $3 million life insurance policy on Joe’s life from a competitive carrier, such as Lincoln Life or Ameritas. The S Corp advances tax-deductible Section 162 bonuses to Michael and David in order to pay for the premiums. It is important to note that Michael and David must report the bonuses as taxable earned income, which is also subject to FICA taxes. Michael and David’s father, Joe, also executes the usual pour-over will and revocable trust for the surviving spouse and family to provide portfolio asset management after Joe’s death.

At Joe’s death, Michael and David receive $3 million of income-tax-free proceeds, which they use to buy equal shares of the S. Corp from Joe’s state. Joe’s estate now has $3 million in cash to distribute to the revocable trust via Joe’s pour-over will. This trust automatically becomes irrevocable at Joe’s death. The surviving spouse has unlimited access to the income and principal of the trust for life to satisfy lifestyle needs. In this example, ownership was passed to the adult children, Michael and David and the spouse who never worked in the business can continue their lifestyle, so everyone is taken care of.

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Family Business Succession Planning
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