Speaker 1:
As a bank that focuses on business, we work with business leaders all day, every day. We have a front row seat to what's working and what has potential. The First Business Bank Podcast is dedicated to sharing insights to help you work better, smarter, and faster to achieve your goals. Let's get into the show.
Mark Meloy:
Hello. I'm Mark Meloy, CEO of First Business Bank. I'd like to welcome you to another episode of the First Business Bank Podcast. Today's topic is Business Succession Planning.
Mark Meloy:
Today, more than ever, this is an issue nearly all businesses and business owners, as well as business leaders, are faced with at some point in time. Yet, the pathway is often unclear. And today, we hope to help bring some mapping to that journey for you.
Mark Meloy:
Today, I'm joined by my colleagues, Christine Waldschmidt, who's an attorney, and Vice President and Trust Advisor with First Business Bank, and Brendan Freeman, who's the President of our Private Wealth Group. Welcome to both of you. How do you define business succession planning?
Brendan Freeman:
Well, Mark, we've all heard the old saying, uh, "You have to start with the end in mind." That's definitely what we're talking about with business succession planning. Uh, business owners have to contemplate what that exit could look like potentially, and that starts with a lot of thoughtful reflection. It starts with talking with individuals that they know and they trust, like our team at First Business, like their CPA or their attorney. Um, but it's really that plan around how they're gonna walk away from the business, or how they're gonna, uh, potentially sell that business or transfer it within their family, transfer it to their employers, that kind of thing. Uh, that thoughtful contemplation is business succession planning.
Mark Meloy:
Good. Christine, from your perspective, is it ever too soon, or is it ever too late to get started in this process?
Christine Waldschmidt:
Well, that's, that's an easy question to answer. It is never, never too soon. And, unfortunately, sometimes it really can be too late. It's always good, when you're running a successful business, it's always good to have in mind where do you see the future of the business going, and always start that succession planning early in the game.
Christine Waldschmidt:
The most critical issue, if your business succession planning is tied in with your family estate planning, and part of your goal is to get the business to your heirs, while minimizing estate taxes, it can, sometimes, be too late. There are so many tools within the tax code that could be utilized to get the business, over time, out of your estate and, ultimately, get it into the hands of your heirs, your children, grandchildren, and hopefully minimizing the estate tax.
Christine Waldschmidt:
There are annual gifting exclusions, and then, of course, the Unified Credit. And using those tools, as early as possible, can eliminate huge amounts of estate tax. Particularly, if you have a young business, and maybe that business, isn't really even showing much of a profit yet? Perhaps it's burdened by some debt. It's in its early stages. If you actually have an opportunity because the relative market value is small, to give that to the next generation, and then all of the appreciation value over time can happen after you've gotten that out of your estate.
Christine Waldschmidt:
I had a client that came in at age 89 and wanted to figure out how to get that business out of his estate and into the hands of his children and grandchildren, and it was too late. His business value, at that point, was far in excess of the Unified Credit, the amount that he could pass without incurring estate tax. And, ultimately, the business had to be liquidated to pay estate tax.
Christine Waldschmidt:
So, it's always good to start early but, particularly, when it's tied to family succession planning and estate planning together.
Mark Meloy:
Brendan, what's the biggest hurdle people face in this process?
Brendan Freeman:
Well, Mark, there's a lot of different hurdles that they'll f- face as business owners, but if I had to boil it down, it'd come down to two things. Uh, one, it would be fear of giving up control. And then, two, would be procrastination.
Brendan Freeman:
What I mean by fear of giving up control, uh, no one's gonna run the business, no one's gonna operate the business, quite like a business owner. Uh, they've invested so much of their blood and their sweat and their (laughs) tears and everything into the business. That sweat equity, uh, has given them comfort over a lo- long period of time. And, so, giving that up is a really difficult, uh, proposition for business owners.
Brendan Freeman:
Uh, the other thing, is procrastination. Uh, you're oftentimes so involved in the day-to-day of the business. These are really, really busy people, oftentimes. And, so, being able to step back and strategize in a thoughtful way, uh, to make sure that they get it right, is something that is better saved for another day. Uh, let's, let's s- stay in the business.
Brendan Freeman:
And, so, uh, you know, as Christine's example talked about earlier, uh, sometimes individuals just wait until it's too late. And, so, we, as advisors, uh, try to encourage our, our clients and business owners that we work with, to start contemplating those conversations and really step back and be a little bit more strategic. But, yeah, those are some of the challenges that they face.
Mark Meloy:
Christine, if people have a hard time getting started, what's a good first step for them to take?
Christine Waldschmidt:
Well, as Brendan said earlier, start with the end in mind. So, if you're not sure where to begin, think about what you want the end product to look like. W- what is your ultimate goal? Do you envision building up this company so you can realize the greatest value in a sale to a third party, and then you can sail off into the sunset? Or are you envisioning transferring control and ownership to key employees? Are you envisioning passing this onto your children?
Christine Waldschmidt:
You have to know what the end goal is, and that will inform the steps that you need to take to get there.
Mark Meloy:
Brendan, what kind of exit options can a business owner consider, and what are the pros and cons of each of them?
Brendan Freeman:
Thanks, Mark. Uh, for those watching or listening to this podcast, uh, the details of what I'm about to describe are available in the show notes below. But there's a few different things to consider.
Brendan Freeman:
Uh, the first is that outright sale, that Christine was just referencing, that kind of sailing off into the sunset, uh, washing your hands of the business, uh, selling the business to a third party, realizing the potential full value, and, and just walking away. And, so, tha- that's, that's a, for many of our business owners, that a, a real positive.
Brendan Freeman:
Uh, the downside of that is that you give up control. Uh, you're, you're no longer involved with the business. You're potentially no longer involved with your employees, uh, with the clients, customers that you've worked with. Um, and, unfortunately, when you do get that big pot of cash, oftentimes, you have to pay the taxman. So, they'll be some capital gains that you might have to incur from that type of, uh, transaction. Uh, but that's, that'd be the first option.
Brendan Freeman:
Next option might be, um, a partial sale, where you take some money off the table. Uh, you do a portion of the business, and you, you know, the, the devil's in the details as far as what you negotiate. But you take some cash off, and you potentially diversify. Uh, this can, for a business owner, this can reduce stress. Uh, and this can potentially allow you to stay in the business in the way that you wanna stay in the business.
Brendan Freeman:
And, so, I've seen situations where business owners still have good client contact. They still are very involved with key customers. Um, they still have regular interaction with certain employees, and they're able to do the things that they wanna do, without the stress of running, uh, the business.
Brendan Freeman:
Uh, another positive of this type of situation, especially in a growth organization, where the company continues to grow, is you might potentially be setting yourself up for another bite of the apple, down the road. And, so, you take some cash off for today, and you set yourself up to potentially realize another financial benefit down the road.
Brendan Freeman:
Uh, the downside here, would be that some of the capital gains, uh, as well as getting used to working with a new partner. If you have a really strong feeling for who that new partner is, maybe that's something you can get over pretty quickly. Uh, but now that they have control, they might operate the business in a different way, and can you get comfortable with that, as a business owner? And, so, uh, depending upon what you negotiate, uh, that's, that's what a, a partial sale could look like.
Brendan Freeman:
A third option might be transferring the business to someone in your family, one of your heirs, as part of a, a broader estate planning strategy. Uh, this is gonna allow you to fulfill on some of the things that you wanna do from an estate planning perspective, and potentially reduce tax. And it also allows you keep the business in the family, and maybe keep some oversight as to what's going on, keep some of those relationships with, with customers and with, uh, employees.
Brendan Freeman:
The downside here is that, oftentimes, when you're doing this, uh, to minimize estate tax, you're not gonna necessarily, uh, have this big liquidity event. You're not gonna have this big pot of cash, and, and you might not be buying that big boat to, to sail off into the sunset. And, so, really thinking through what your motivation, what your goal might be. Uh, and if, if estate planning is the primary motivation or the goal, th- this might work, if keeping it in the family i- is, is the goal, this also might work. But there's gonna be pluses and minuses to that situation.
Brendan Freeman:
Uh, an additional one might be to transfer the company to a key employee or maybe a third party, by taking on a note or setting up some type of arrangement with a buy-sell and a shareholder agreement, where there's a predetermined value. And maybe this is tied to incentive compensation.
Brendan Freeman:
There is pros to this, in the fact that you can protect employees, especially if those employees are critical to running the business or, uh, critical to the customer base. You can maintain control by doing this.
Brendan Freeman:
But the downside, again, is that you're not gonna have the, the large lump sum of cash, and it might not help you as far as realizing some of those dreams that you'd hoped to, to realize.
Brendan Freeman:
Um, the last option, and a very employee-friendly option, is what's commonly referred to as an ESOP, and that's an Employee Stock Ownership Plan. Uh, that's a great way to protect your employees. That's a great way to take care of those senior leaders within your business and have continuity within the business, to continue serving your customers and to continue taking care of those employees. These employees feel a great sense of ownership with an ESOP, and there are several tax benefits to an ESOP.
Brendan Freeman:
The downside here, uh, can be that's it's very costly, uh, to set up and to maintain. And it can t- take significant time, as far as the administration, as well as the employee education component, Mark, that comes with this.
Brendan Freeman:
And, so, high level, those are the, the, the different options, uh, from, from a transition perspective. Uh, but, with, with, a, a lot of thought that goes into each of them, uh, because there are definitely pluses and minuses.
Mark Meloy:
Mm-hmm (affirmative). Mm-hmm (affirmative). Christine, what if the business owner just doesn't have a solution? You've, you've outlined all these different options to 'em, and they're just not sure that they can make a decision. Is there a ... I- is there anything that can be considered at that point in time or providence that we, as experts, might provide in that, in that consideration?
Christine Waldschmidt:
Mark, that is a very common situation, in fact. Oftentimes, because business owners want their cake, and they wanna eat it too. They want everything. They want to minimize estate taxes, but they don't wanna give up control. They want to realize a big payoff and sail off into the sunset, but they, again, don't wanna give up control, and, and want to have input on what the future of the company looks like.
Christine Waldschmidt:
And oftentimes, the conflicting pulls, because, well, in theory, yes, they have estate planning goals. Uh, they understand that they're not going to be running the business forever, and they have to have a succession plan in place. They have to, ultimately, every business owner has to ultimately decide, "What are my priorities?"
Christine Waldschmidt:
And you have to force-rank them. You have to decide, "Yes, these things are all important. Which is more important?" And only after you have done that forced ranking and really decided the estate planning and, and moving this to my heirs has to take precedence over realizing a big payout, or whichever, or the other direction. But you have to decide as a business owner, which is more important? Which end goal is more important?
Christine Waldschmidt:
And once you can really make yourself do that forced ranking of priorities, again, then you can back up and figure out what you need to do to make that happen.
Christine Waldschmidt:
And, truly, your actions and the steps you're going to take, are going to be very different. If you're looking at transferring to the next generation, and you're trying to structure minority discounts and figure out how to get this out of your estate, you're not trying to maximize value in that setting, You're trying to come up with actually the most modest evaluation that the IRS will buy.
Christine Waldschmidt:
Flip side, if you're trying to market to an outside third party, you wanna polish this gem up and squeeze every penny of the transaction and get the highest dollar value you can. I, I say that because it's really important. I've had people start in and make stabs at creating valuation, when they aren't sure what direction they're going. And I tell them, "Stop. You don't wanna get a valuation that you would use to market to a third party and have that out there, as, as evidence to be used against you (laughs) when you're trying to do a minority discount."
Christine Waldschmidt:
So, think about it. First, rank your priorities, and then start at the beginning.
Mark Meloy:
Good. Good. Brendan, what about the owner that just doesn't wanna retire?
Brendan Freeman:
Yeah. Yeah, this is, uh, happens more than, than you think, right? Uh, uh, again, going back to what I was talking about earlier and, and your identify being driven by, uh, the business that you run.
Brendan Freeman:
You know, in many cases, uh, y- you see situations where it ... Business owners just love what they do. And they, they love their employees. They love their customers. And, and they're not quite ready.
Brendan Freeman:
And, so, I think there's a difference between owning the business and being employed by the business. And, oftentimes, when you're in the (laughs) business, it's, it's, it's tough to (laughs) differentiate. But with a thoughtful, uh, uh, business succession plan and thinking through what makes the most sense for you, you can differentiate between being the owner and being an employee.
Brendan Freeman:
And what I'm talking about here is, you can, in the negotiation, uh, of a potential sale, as an example, you can negotiate a consulting contract. You can negotiate to stay on with the business for a period of time. And you can also negotiate that you wanna do the things that you love doing, or that you think are the most valuable to the business.
Brendan Freeman:
And, so, uh, thinking through those details and kind of putting on that hat as an employee, compared to the hat of an owner, i- is, is different, uh, but it's certainly something that we've seen, uh, many business owners do in this type of transition. And, so, it doesn't necessarily mean that you have to retire.
Brendan Freeman:
Now, on the other hand, if you wanna retire and sail off into the sunset, uh, you know, y- you can do that too.
Mark Meloy:
Those are great thoughts, and I hope that we've, uh, brought some answers and some mapping to our audience today.
Mark Meloy:
Christine and Brendan, thank you for taking time to share your thoughts and experiences with our audience today. And to you, our audience, thanks for listening in our conversation. We hope you found this topic helpful and applicable to your company, as well as to your own planning.
Mark Meloy:
And let us know if there are topics or information you'd like to learn more about. And join us next time on the First Business Bank Podcast.
Speaker 1:
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Speaker 1:
Thanks so much for listening. First Business Bank, Member FDIC.