Law: Is Junior really the best person to take over your company?

Two weeks ago Business 380 featured interviews discussing the leadership transfer at Rockwell Collins from longtime CEO Clay Jones to new CEO Kelly Ortberg. Likewise, many local not-for-profit organizations in the Corridor are discussing succession planning as some longtime leaders approach retirement.

Which begs the question: What will happen to your business if you are no longer able to or want to lead it?

Without a structured plan in place, a small business could be put in jeopardy in the event of a retirement, divorce or the disability or death of one of the key owners. One statistic claims that only 34 percent of family businesses are successful in transferring assets from the first to the second generation, and only 14 percent are successful in transferring a business from the second to the third generation.

Besides the legal and tax issues involved when passing on a family business, there are many personal and emotional issues, fraught with apprehension and even fear. But whatever the obstacles, it is time to put succession planning on your to-do list.

Here are some thoughts to assist you in the process:

1. Start now - When is the best time to plant a tree? Fifteen years ago.

In this case, start at least five years in advance. Get outside help. Work with your lawyer, CPA, financial planner or other professional and let them get you organized and thinking about the key issues you will face in transferring leadership and/or ownership.

2. Be realistic - Can your first-born son or daughter run the business successfully? Is there a better qualified existing employee?

3. Transition - Whomever you choose, spend time training them before handing over the reins. Introduce them to your top customers and take the necessary measures to ensure your company's continued success.

This will benefit you as well - you want the company and its new leader to be successful in his or her own right to guarantee your future equity payments.

4. Preserve your equity in the business and minimize potential tax liability - There are many legal options to do so, including structured buyouts, establishing family limited partnerships, but you need to know the tax consequences of gifting the business.

A buy-sell agreement allows you to specify a course of action when a “trigger event” occurs such as death, disability, divorce or a withdrawing owner otherwise places the business in jeopardy - failure to reach performance goals, for example.

Such agreement refers to how an owner's shares may be sold, to whom, and at what price upon his or her departure. One commentator has referred to it as a prenuptial agreement for businesses.

5. Put it in writing - While it may seem cold, the health of your business should not be dependent on a “handshake” deal. Put the deal in writing.

6. Expect to perform due diligence - If you are selling outside your family, expect the buyer to request to inspect your records. Of course, a family member may require a due diligence review, also.

As the seller, you should do likewise to make sure the buyer can pay you. Before sharing any such information, have your lawyer draft a joint confidentiality agreement for both sides to sign.

7. Taking the business back - If the buyer cannot make the payments or is otherwise mismanaging the business in violation of the agreement, you will need to have the ability to take the business back written into the agreement.

8. Noncompete agreements - You want the new business to be prosperous, so do not be surprised if the departing leader or owner is asked to sign a noncompete agreement. If the person is definitely retiring, this should not be a big deal.

However, some owners have been known to let the noncompete agreement run out, and then jump back into the business under a new name and competing against his or her old company. To avoid this, make sure your noncompete agreement is reasonable in time and scope.

One Iowa case found a seven-year noncompete agreement within a 350-mile radius was too restrictive. The employee in that case went to court after four years to get out of the remaining three years on the noncompete agreement and was successful. Most cases seem to find one to three years as reasonable while the geographic restrictions depend on the market area.

Conclusion: Prepare now to choose your successor and assemble a team of advisers to assist you execute your plan flawlessly.