Local experts provide valuable tips on succession planning for business owners

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The successful transfer of a business — within the family, to a current employee or to outside interests — takes meticulous planning and implementation of a variety of tax strategies to maximize value while also preserving the legacy.

None of it happens overnight, either. If you’re looking to transfer ownership this year, your planning should have started long ago, as in a year, or years, ago.

“I don’t think I can emphasize enough that preparation is really the key to a successful transition of an organization,” said Timothy Minneci, managing director at Paramax Corp., a middle market investment banking firm headquartered in Meridian Centre Park in Brighton.

That’s why Minneci advises business owners to live by the “As-if, Even-if” adage.

“You’re going to plan each year as if there is a transition taking place, even if that transition isn’t on the horizon,” Minneci said during the Rochester Business Journal’s July 25 Virtual Panel Discussion on succession planning. “By doing that, you’re really going to prepare the company for that transition.”

Even with long-term planning, there will be hurdles of some sort. Something will pop you didn’t expect and it will take a little time for both the buyer and seller to feel comfortable with all aspects of the transaction. Eventually, however, all the complexities will fit together.

“Succession planning is like a puzzle,” said Jim Schnell, partner in the taxation department at MMB+CO. “These are the puzzle pieces; you have to put them together in a way that ultimately is going to be a fit for you, obviously, and the buyer.”

Those surprises, as well as obstacles, can be minimized if all essential advisors — starting with your lawyer(s) — are part of the equation from Day 1.

Watch a free recording of the Business Succession Planning discussion

“There’s that tug of war that happens between the buyer and seller, and why you want your legal advocates in the room with you. They’re going to advocate for you,” said Danielle Ridgely, partner and practice leader within the tax group at Woods Oviatt Gilman, a firm routinely representing buyers and sellers in the middle market space.

When contemplating a succession plan, Minneci said there are several questions that will require answers:

• What’s my business worth?

• How long do I want to keep working?

•Is there someone in the company that can run the company?

• Are my children interested and/or capable of running the company?

Once you have those answers, it’s time to settle on exit alternatives:

• Generational succession – keeping the business in the family.

• Inside sale to key employees.

• Staged sale to outside parties.

• Sale to a single outside buyer.

• Initial public offering, which is reserved for those businesses that can meet certain size thresholds.

• Liquidation, which is certainly the least-favorable transition alternative (according to Minneci).

Whichever avenue is chosen, it is critical to structure the deal properly. Schnell says don’t fixate on the sale price. The tax structure can be far more important.

“Taxes are an extremely large part of how a deal ultimately gets structured and what you walk away with,” Schnell said. “The tax effect of the deal is much more important than the sale price.”

That’s true whether the business stays in the family or is sold to outside interests. If you’re considering an ownership transfer to the next generation, then it might be wise to consider gifting equity in the business to that person or those persons now because tax laws are scheduled to change, Ridgely said.

“The current unified exclusion amount is $3.61 million per person,” she said. “That will be cut in half in 2026, unless Congress changes the law. It’s a way to gift to the next generation and maximize the tax-free gifting at this time.”

What lies ahead in terms of project contracts also can be a critical component in negotiations. Future revenue, aka earn-outs, may add to the value, so the final sale price could include a clause that provides added money for the seller based on future contracts.

Schnell said he recently finalized a deal where both parties agreed on what the business was worth today: $10-12 million. “There was no confusion,” he said.

But because there were contracts in place that had yet to play out, the seller believed he should receive a more significant final value price.

“We ultimately did the deal at $18 million with a $12 million purchase price and a $6 million earn-out that the buyer was more than happy to pay out if the contracts came to fruition,” Schnell said.

While passing the business on to the next generation is often preferred and seen by the business owner as the preferred alternative, it’s not always practical. Sometimes the children or other relatives aren’t interested. And there isn’t always a current employee who is interested or is the right fit, either. Don’t fret. Venture capitalists have their eyes on a variety of industries.

“There is a lot of private equity capital money in our society,” Schnell said. “You’d be surprised getting down into that $5 million-$25 million revenue space that your business absolutely will have an audience in a broader market. What may not have existed in that space 15-20 years ago really does today.”

Understand, though, that the private equity investors aren’t experts in your company and maybe not in your industry. They may want you to stay on as a minority owner for a finite period to provide guidance and insight. But you’ll need to come to grips with the fact it’s no longer your business.

“Obviously ceding control once you sell more than 50 percent of your equity, you do not control the company any longer, so that’s an important thing to keep in mind,” Schnell said.

Along the way during due diligence and negotiations there very likely will be documents to sign, starting with a non-disclosure agreement (NDA). The buyer will be doing a deep dive into the books, personnel and company reputation, but that insider look cannot ever be shared.

With that NDA, the seller is saying, “I’m going to let you see more information about my company, that is very private and proprietary, and it cannot be used for any other purpose other than the discussion of you buying into or buying my company,” Schnell said.

He said it is becoming increasingly more common, especially when private equity is involved, that a quality of earnings analysis report is run. In doing that thorough examination of operations, the buyer has a much better understanding of value.

A letter of intent (LOI) for purchase also will very likely come into play later in negotiations. Don’t enter such an agreement on your own, Ridgely said.

“Bring lawyers into the room before you sign an LOI,” Ridgely said. “Even if it’s not binding, it’s hard to stray away from that. Bringing the advisors on later in the process sometimes means they’ll need to make lemonade out of lemons.”

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