Succession Planning: Part Two
Previously, RubinBrown's Construction Services shared the important steps a construction company should take to begin a succession plan for their company. After building value and communicating objectives to your fellow leaders, you are ready for the next steps in the process.
Groom A Successor
Once the goals have been discussed and agreed upon, choosing and grooming a successor follows.
This is an important piece of the succession plan because it is the successor who is able to utilize the owner’s intangible assets. The owner has knowledge, skills, and relationships that other employees may not possess.
When evaluating successors, it is essential to identify and quantify the right qualities for each position. Both hard and soft skills should be evaluated, as well as behavior.
A successor’s behavior, such as natural leadership and ability to work with others, plays an important role in selecting a successor. Another important quality is the successor’s desire.
Attaining ambition comes from giving them adequate training and development, necessary leadership experience and quality mentorship.
The next and most complex step is to decide how to transfer ownership. Contributing to the complexity is the multitude of ways ownership can be transferred.
Gifting stock is an effective way of passing stock to successor individuals and in turn, reducing the estate of the original stock owner. And while gifting stock can seem self-explanatory, many considerations need to be taken into account. These considerations include the annual gift exclusion, future appreciation of the stock, and voting versus non-voting stock.
An alternative to gifting is a stock redemption. To qualify for a Section 303 stock redemption, the deceased must have corporate stock that makes up 35% or more of their adjusted gross estate.
Therefore, this is a good option for families where a corporation constitutes the majority of the family’s wealth. Under this code section, a corporation may redeem its stock from the estate on a tax-favored basis in an amount equal to the decedent’s estate taxes and administrative expenses. In many instances, the redemption may be part of a buy/sell agreement.
Buy/sell agreements are also an effective method to transfer ownership. With a buy/sell agreement, the price of the stock is based on a predetermined valuation.
An ESOP is another succession planning opportunity that requires annual valuations. An employee stock ownership plan, or ESOP, allows owners to sell up to 100% of their stock to a defined benefit plan that is owned by its own employees. Therefore, the employees of the business become shareholders in the company.
Another choice is stock recapitalization. Both common and preferred stock can be recapitalized, but the benefits of each vary. Common stock recapitalization enables a shift in voting power to successors that will operate the company.
Preferred stock recapitalization can shift future increases in corporate value to those who own common stock and freeze the value of the estate of a principal stockholder, so the subsequent increases in value go to the common stock held by their heirs. As you can see, this option provides a lot of flexibility for estate planning.
Estate planning is the last step in the process. However, this step should be considered throughout the planning process. Make sure you can clearly answer the following questions:
- What do I want to leave to my family?
- Do I have the financial capacity to retire?
- What are the tax consequences of my succession plan and beyond?