Business Succession Planning
Whether retirement is many years away, just over the horizon, or not in your game plan at all, a Succession Plan is vital to ensuring the continued success of any business.
Succession planning may be the single-most neglected aspect of business ownership. Don't make the same mistake that so many others have.
Succession Planning is an essential element of any business and is a process that requires a full-on strategic plan to ensure operational continuity.
Simply put Business Succession Planning is a not one-size-fits-all strategy or a one-time event. Planning for "succession" requires an investment of time and effort. It should be part of your overall Estate Plan. Whether you are executing a carefully developed "Succession Plan" or reacting to a sudden leadership departure of an owner or partner, you need the full array of legal and strategic services to support your business through the transition.
This is especially true when it comes to family-owned businesses. As the editors of Inc. Magazine have noted, "Strategic planning—centering around both business and family goals—is vital to successful family businesses. In fact, planning may be more crucial to family businesses than to other types of business entities, because in many cases families have a majority of their assets tied up in the business. Since much conflict arises due to a disparity between family and business goals, planning is required to align these goals and formulate a strategy for reaching them. The ideal plan will allow the company to balance family and business needs to everyone's advantage."
No Company can survive without an able Owner or CEO at the helm. In the event of a Key Person's sudden death, illness, or retirement, businesses are often left scrambling to find a suitable replacement. Large corporations and small businesses alike can avoid a turbulent transition by establishing a Succession Plan with an experienced and knowledgeable attorney.
Start planning today!
WITHOUT A PLAN
If an Owner or Major Shareholder does not have a Succession Plan in place, his or her stake in the Company is either passed on to relatives as part of the Estate Distribution Process, absorbed by other Shareholders, or a combination of the two. In Family-Owned Businesses, this often leads to disputes between siblings and other relatives. Those more active in the day-to-day operations of the Business may feel entitled to larger shares than others who are less involved.
WITH A PLAN
An attorney with expertise and experience in Business and Estate Planning can help Owners and Shareholders create and implement a plan that facilitates a smooth transition. Plans are customarily created after Employees, Co-workers, Shareholders, and Family Members have been consulted, and goals for the future of the Company have been outlined.
Succession Planning can be tailor-made to fit any business model and should address the following issues:
- Keeping the Business or Shares within the Family; a Spouse, Children, or other Relatives can retain control of assets.
- Offering other Shareholders or Key Employees a more significant stake in the Company.
- Stipulating that other Interested Parties can be granted the right of first refusal, or the ability to accept or reject the shares of the exiting or deceased Owner before they are offered to individuals outside of the company.
- Pricing the shares through a valuation mechanism agreed upon during the Succession Plan negotiations. For example, a valuation mechanism may require that shares be offered at their prevailing market value or require multiple professional business valuation appraisals.
- Incorporating issues related to your Personal/Family Estate Plan, as well as, the minimization of potential Estate Taxes.
- Preserving “Institutional Memory” when Key Employees are no longer managing the Business.
- Arranging the transfer of the Owner's or Executive's Interest into Trusts to be paid out to Family Members.
- Establishing measures to ensure the Business has enough cash flow to pay taxes or buy out a deceased Owner's share of the company.
- Implementing a Family Employment Plan with Policies and Procedures regarding when and how Family Members will be hired, who will supervise them, and how compensation will be determined.
- Dividing assets among employees, or in certain cases, selling the company.
With so many factors to consider, it is essential that you consult an experienced Business Planning attorney who can understand all of the interests at stake and work with you to protect them.
CORPORATE AND BUSINESS FREQUENTLY ASKED QUESTIONS:
Why should I incorporate?
There are two primary reasons for incorporating your business. One is to limit your personal liability for obligations and debts of the company, providing that you follow the requirements that will keep your corporate veil intact. To retain this corporate veil, you must run your corporation like a business, not co-mingle your personal and business funds and not engage in criminal or fraudulent acts. By incorporating, you generally can limit your potential loss to whatever you and others have invested in the business and/or the business's assets.
The second primary reason for incorporating your business is that incorporating gives you a more professional image. Often investors, lenders, customers, and suppliers may prefer to deal with a Corporation or LLC because it seems better organized and more substantial than an Unincorporated Business.
Other benefits of incorporation can include greater use of legitimate Tax Deductions for Health Insurance and Medical Expenses, lower payments for Social Security and Medicare Taxes, and greater opportunity to raise Capital for the Business through the issuance of Stock.
When does a corporation's existence begin?
Under the Corporate Laws of some States, corporate existence begins when the Articles of Incorporation are filed with the Secretary of State. Under an older practice still followed by many States, corporate existence begins upon the issuance of a Certificate of Incorporation by the Secretary of State.
Does a corporation have to issue stock?
Yes. Shareholders are the owners of the Corporation. If no shares of stock are issued, then there are no legal owners of the Corporation. Shares must be issued to those individuals who will be owners of the Corporation. This is the case even if only one individual will own the Corporation.
In some circumstances, a Corporation can sell shares of stock to investors in order to provide the Corporation with its own capital. The sale of securities is heavily regulated by both the State and Federal Governments, and we recommend that you contact an attorney in your State of Incorporation before issuing stock.
How many shares should I authorize?
There is no minimum number of shares that must be authorized in the Articles of Incorporation, but the Corporation may not sell more shares than it is authorized to issue. The number of authorized shares can be increased or decreased by filing an amendment to the Articles of Incorporation with the Secretary of State.
What is a Registered Agent?
Most states require that a Corporation have a Registered Agent who maintains a registered office within the State of formation. This address of the Registered Office may be different from the Corporation's Business Address. This individual or service company must be responsible for receiving important legal and tax documents. The Registered Agent must have a valid street address within the State of Incorporation and be available during normal business hours to receive documents.
The services performed by a Registered Agent include, but are not limited to:
- Receiving and forwarding legal documents.
- Receiving and forwarding tax and report forms.
- Accepting and forwarding service of process.
What is an "S" Corporation?
An "S" Corporation is merely a Corporation that has elected a special Tax Status. This tax treatment permits the Corporation's income to be treated like the income of a Partnership or Sole Proprietorship in that the income is "passed through" to the shareholders. Thus, shareholders report the income or loss generated by the "S" Corporation on their individual tax returns, avoiding double taxation.
In order to be considered an "S" Corporation, the stockholders of a properly filed Corporation must elect such status within seventy-five (75) days of formation for the current tax year or at any time during the preceding tax year. This election is made by filing Form 2553 with the IRS.
The ownership of an "S" Corporation is subject to certain restrictions. "S" Corporations can have no more than one hundred (100) shareholders, cannot have any non-US resident shareholders, and cannot be owned by C Corporations, other "S" Corporations, many Trusts, LLC's or Partnerships. In addition, "S" Corporations are not allowed to own eighty (80%) percent, or more, of another Corporation's shares.
To qualify for S Corporation status, a Corporation:
- Must be a Domestic Corporation
- Have only allowable shareholders
- May be individuals, certain trusts, and estates and
- May not be partnerships, corporations, or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e., certain financial institutions, insurance companies, and domestic, international sales corporations).
What is a "C" Corporation?
A "C" Corporation is merely a Corporation that pays the tax directly to the IRS. A "C" Corporation can be contrasted with an "S" Corporation, which generally doesn't pay tax.
"C" Corporations offer unlimited growth potential through the sale of stock. In addition, there is no limit to the number of shareholders a "C" Corporation can have.
Advantages of a "C" Corporation.
There are many benefits, here are just a few.
- Limited liability. This applies to directors, officers, shareholders, and employees.
- Perpetual existence - Even if the owner/shareholder leaves the company.
- Unlimited growth potential. The sky's the limit, thanks to the sale of stock.
- No shareholders limit. (Once the company has $10 million in assets and 500 shareholders, it is required to register with the SEC under the Securities Exchange Act of 1934.)
- Certain tax advantages. Enjoy tax-deductible business expenses.
Disadvantages of a "C" Corporation.
Having unlimited growth comes with a few minor setbacks.
- Double taxation. It's inevitable as revenue is taxed at the company level and again as shareholder dividends.
- While the double taxation of "C" Corporations is a drawback, the ability to reinvest profits in the company at a lower corporate tax rate is an advantage.
- Regulations and formalities. "C" Corporations experience more government oversight than other companies due to complex tax rules and the protection provided to owners from being responsible for debts, lawsuits, and other financial obligations.
- No deduction of corporate losses. Unlike an "S" Corporation, shareholders cannot deduct losses on their personal tax returns.
"C" Corporation vs. "S" Corporation.
Both "C" and "S" Corporations offer limited liability protection. Both require Articles of Incorporation to be filed. And both comprise shareholders, directors, and officers. There are numerous similarities, but they differ in the complex realm of taxation and corporate ownership.
As noted, "C" Corporations are subject to double taxation. In contrast, "S" Corporations are pass-through tax entities, allowing them to avoid being taxed at the corporate level and again on shareholders' personal income taxes.
Taxation. Taxation is often considered the most significant difference for small business owners when evaluating "S" corporations vs. "C" corporations.
- "C" Corporations. "C" Corporations are separately taxable entities. They file a corporate tax return (Form 1120) and pay taxes at the corporate level. They also face the possibility of double taxation if corporate income is distributed to business owners as dividends, which are considered personal income. Tax on corporate income is paid first at the corporate level and again at the individual level on dividends.
- "S" corporations. "S" Corporations are pass-through tax entities. They file a federal informational return (Form 1120S), but no income tax is paid at the corporate level. The profits/losses of the business are instead “passed through” the business and reported on the owners' personal tax returns. Any tax due is paid at the individual level by the owners.
- Personal Income Taxes. With both types of corporations, personal income tax is due both on any salary drawn from the corporation and from any dividends received from the corporation.
When it comes to corporate ownership, "C" Corporations have no restriction on ownership, and therefore, have unlimited growth potential. But "S" Corporations are restricted to no more than 100 shareholders. Also, "S" Corporations cannot be owned by a "C" Corporation, other "S" Corporations, LLCs, partnerships, or many trusts. A "C" Corporation, however, has no limits on who or what can be a shareholder.
What is an LLC?
A Limited Liability Corporation or LLC is a relatively new type of business; Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship; it is an incorporated entity that provides limited liability to its owners or members, and it has the unique opportunity to elect the tax structure that best fits the LLC's specific needs. The limited liability company is a “hybrid” entity created to provide the liability benefits of a partnership.
A limited liability company is a statutory entity that articles of organization in order to exist. The owners, called members, enter into an operating agreement. This is the basic governing document, which provides for the regulation of the affairs of the company, the conduct of its business, and relations among the members and managers.
While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of partnerships (and not an LLC).
One of the key features of a limited liability company is that its owners have limited liability. The individual assets of LLC members may not be used to satisfy the LLC's debts and obligations. A member's risk of loss is limited to the amount of capital invested in the business. However, it is possible that a court may “pierce the veil” and hold a member liable for the LLC's acts if the member completely dominated the company, did not treat it as a separate entity, used the LLC form to perpetuate wrong or injustice, or where it otherwise would be considered unfair to treat the member and company separately. Some acts specifically provide that an LLC's corporate veil may be pierced to the same extent any corporation may be pierced. However, even in the absence of such a provision, the courts have held that the concept of veil piercing applies to LLCs.
LLCs may elect not to pay federal taxes. Instead, profits and losses are listed on the personal tax returns of the owner(s). Or, the LLC may choose a different classification, such as a corporation. If fraud is detected or if a company hasn't met legal and reporting requirements, creditors may be able to go after the members.
An LLC may be taxed for federal income tax purposes like a C corporation, an "S" corporation, a partnership, a sole proprietorship, or a division. The tax regulations contain default classifications under which an LLC with two or more members will be taxed as a partnership, and an LLC with one member will be disregarded as an entity. However, an LLC can change its classification to a corporation by filing a form with the IRS called an "Entity Classification Election."
If an LLC is taxed as a partnership or a disregarded entity and the LLC will not have to pay an entity, its tax items will flow through to the member or members, and the entity will not have to pay entity-level tax.
If the LLC elects to be taxed as a "C" corporation, it will be taxed as an entity. The LLC will have to file a federal tax return and pay taxes on income it earned. It will also be subject to double taxation because, in addition to its income being taxed at the entity level, any profit distributed to the members will be taxed again as personal income.
What is a Federal Employer Identification Number?
A Federal Tax Identification Number (also known as an Employer Identification Number, or "EIN") is used to identify a business entity for taxation purposes. What a Social Security number is to an individual, the Federal Tax I.D. Number is to the Corporation. Generally, any corporation doing business within the U.S. is required to have an EIN. In fact, the EIN is necessary when filing tax returns and for establishing bank accounts.
A Corporation can receive an EIN by completing and submitting IRS Form SS-4.
In which State should I incorporate my business?
A Corporation is not required to incorporate in the State in which it operates; therefore, you can incorporate in any of the fifty (50) States. There are many considerations involved in deciding where to incorporate, including the cost of incorporation, tax laws, and general laws governing the actions and liabilities of Corporations. You can choose to incorporate in the State that is most advantageous to you.
Certain issues are involved when determining the proper State in which to incorporate your Business. First, you must consider the costs of incorporating in your home State vs. the costs involved in qualifying as a foreign corporation in another State. Second, you must determine the advantages and disadvantages of each State's Corporate Laws and tax structure. And of course, there are many others determined by your particular situation.
Do I have to live in the State where I am incorporated?
Not at all—you may incorporate in any State of your choosing. While an In-state Registered Agent is required, that Registered Agent does not need to be an individual otherwise connected to the company. In fact, it doesn't even have to be an individual. Another incorporated business (other than the one you're in the process of forming) can act as your Business's Registered Agent, as long as it has already been incorporated in that State. You can nominate your own, or we can obtain a registered agent in any state you like on your behalf.
What's a Registered Agent? Do I need one?
While you're not required to be physically present in the State in which you wish to incorporate, the State does require that someone who is physically located within the State is on file. Why? The Registered Agent is the point person for your company, and the contact information is usually a matter of public record; your Registered Agent will receive correspondence from the State, inquiries from the Public, and Service of Process in the event of a lawsuit.
What do the designations "Domestic Corporation" and "Foreign Corporation" mean?
A Corporation is called a Domestic Corporation with respect to the State where it has been incorporated. Any other corporation not incorporated within that State is called a Foreign Corporation. For example, a Corporation incorporated in Nevada is a Domestic Corporation in Nevada but is considered a Foreign Corporation in all other States. A Corporation will normally have to qualify to do business in a State where it is not incorporated.
How does a Foreign Corporation qualify to do business in another state?
Before doing business in another State, a Foreign Corporation generally must register with the Secretary of State of that State, file copies of its Articles of Incorporation, pay certain taxes, and appoint a Resident Agent within that State for Service of Process.
What is meant by the phrases doing or transacting business in another State by a Foreign Corporation?
There are many factors used to determine whether a Foreign Corporation is transacting business in a State, and therefore, must qualify to do business in that State. Some criteria evaluated include:
- Whether the company has a physical presence in the State;
- Whether the company has employees in the State;
- Whether the company accepts orders in the State;
- Whether a company is selling products or services in that State; and
- Whether the company has a bank account in the State
This is not a complete list, and different States may have different criteria. However, these are some common factors to consider when trying to determine whether it is necessary for a Foreign Corporation to register or qualify to do business in another State. It is necessary to follow the laws of each State if you are doing, or intend to do, business in another State
For example, many entrepreneurs incorporate in Nevada or Delaware due to the tax laws and for other beneficial reasons, but they do not reside and/or transact any business in either of those States. Therefore, those entrepreneurs must register their Corporations wherever their "businesses" are physically located and/or they transact business.
I have heard that a Corporation can be a citizen of a state. What does this mean?
For certain purposes, such as determining the right to bring a lawsuit in Federal Court, a Corporation today is deemed a citizen of any State in which it has been incorporated AND also of the State where it has its principal place of business. Therefore, a Corporation can be a citizen of more than one State.
For example, a Corporation incorporated in Pennsylvania is a Pennsylvania Corporation. A Delaware Corporation having its principal place of business in Pennsylvania is deemed to be a citizen of Pennsylvania, as well as, Delaware.
How is the business of a Corporation carried out or managed?
The owners of a Corporation are its shareholders. The shareholders elect a Board of Directors to oversee the major policies and decisions of the Corporation. The Board of Directors also elects the Officers who are responsible for the management of the business of the Corporation. Thus, the dealings of the Corporation are carried out by the Officers and Employees of the Corporation under the authority delegated by the Directors of the Corporation.
How many Directors are necessary?
Generally, in most States, a Corporation is only required to have One (1) Director, although you can have more. Certain States base the required number of Directors on the number of stockholders.
What are the General Duties of Directors?
Each Director must attend meetings of the Board, which must be held no less than once a year. Each Director on the Board is given one vote. Usually, the vote of a majority of the Directors is sufficient to approve a decision of the Board. Directors must make sure that major corporate actions are recorded (e.g., minutes of meetings) and were taken on behalf of the Corporation. Corporate Officers are elected by the Board of Directors and are responsible for conducting the day-to-day operational activities of the Corporation. Terms of Directors often are for more than one (1) year and are staggered to provide continuity. Shareholders can elect themselves to be on the Board of Directors.
What Officers are elected by the Directors?
Corporate Officers usually consist of the following: a President, Vice-President, Secretary, and Treasurer, though one person may hold more than one office.
Who actually owns the property of a Corporation?
A Corporation is an artificial person that is created by governmental action. The Corporation exists in the eyes of the law as a person, separate and distinct from the persons who own the corporation (stockholders). This means that the property, or assets, of the Corporation are not owned by the stockholders but by the Corporation. Debts of the Corporation are debts of this artificial person and not of the persons running the Corporation or owning shares of stock in it. Thus, the "value" of the Corporation, and its stock, is determined partially by the amount or "value" of the Corporation's assets versus its liabilities or debts.
How do the initial shareholders fit into the ownership of the Corporation?
Shares must be issued to those individuals who will be owners of the Corporation. This is also the case even if only one individual will own the Corporation. Ownership of a Corporation can be transferred by the sale of all or a portion of the stock. Additional owners can be added either by selling stock directly from the Corporation or by having the current owners sell some of their stock. Small businesses that are incorporated are often owned by a small group of shareholders who all work in the business. Often these shareholders formally agree to certain restrictions on the sale of their shares, so they can control who owns the Corporation.
What are Security Laws?
Securities Laws are meant to protect investors from unscrupulous business owners. These Laws require Corporations to follow certain procedures before accepting investments in exchange for shares of stock (the “securities”). Technically, a Corporation is required to register the sale of shares with the Federal Securities and Exchange Commission (SEC) and its State Securities Agency before granting stock to the initial corporate owners (shareholders). Many small Corporations are exempted from the registration process under Federal and State Laws. For example, SEC Rules do not require a Corporation to register a “private offering,” which is a non-advertised sale of stock to a limited number of people (generally thirty-five (35) or fewer). The laws in this regard can be complicated, and the sale of stock should be managed by attorneys who are experienced in that regard.
What does it mean to "Pierce the Corporate Veil?"
Ordinarily, a Corporation will be regarded and treated as a separate legal person, and the law will not look beyond a Corporation to see who owns it and hold those individuals liable or accountable. However, a Court may disregard the Corporate Entity's status and pierce the corporate veil in exceptional circumstances and hold the individual shareholders liable for the acts of the Corporation. The decision whether to disregard the Corporate Entity and go directly against the shareholders is made on a case-by-case basis, and Courts generally will look to more than one factor. Factors that may lead to piercing the corporate veil are:
- Failure to maintain adequate Corporate Records and the commingling of Corporate and Personal Funds;
- Grossly inadequate capitalization (debt/equity ratio too high);
- The formation of a Corporation to evade an existing obligation;
- The formation of a Corporation to perpetrate a fraud;
- Improper diversion of Corporate assets; and
- Injustice and inequitable circumstances would result if the Corporate Entity were recognized and the veil was not pierced.
A Court will not go behind the Corporate Identity merely because a Corporation has been formed to obtain tax savings or to obtain limited liability for its shareholders. One-person, family, and other closely-held corporations are permissible and fully entitled to all of the advantages of Corporate existence. However, factors that lead to piercing the corporate veil more commonly exist in these kinds of Corporations. It is extremely difficult to pierce a corporate veil in most situations. Some Courts use different terminology when disregarding the Corporate Entity. The Court may state, for example, that the Corporation is merely the alter ego of the shareholders, and the shareholders should therefore be held liable.
What are Mergers and Acquisitions?
Mergers and Acquisitions is a phrase used to describe certain types of financial activities in which Corporations are bought and sold. A merger occurs when two corporations merge into one entity, where one absorbs the other. One Corporation preserves its original charter and identity and continues to exist; the other Corporation disappears, and its Corporate Existence terminates. Generally, the Corporate Entity that continues the business after a merger will succeed to all of the rights and property of the other Corporate Entity and will also be subject to all of its debts and liabilities.
A Corporation may merely purchase or acquire the assets of another Corporation. This would NOT be a merger. In an acquisition, the purchasing Entity buys the assets of the other Corporate Entity but does not become liable for the debts and obligations of the Corporation being acquired.
What is a Holding Company?
A Holding Company is a Company/Corporation created to own the stock of other Corporations, often using the stock holdings to control the management and policies of those Corporations.
What is an Annual Report?
An Annual Report is a document that must be filed with the Secretary of State each year. This Report generally must indicate:
- The Corporation's name and its State or Country of incorporation;
- The address of its Registered Office and the name of its Registered Agent at that Office in the State;
- The address of its Principal Office, which may or may not be the same;
- The names and business addresses of its Directors and Principal Officers;
- A brief description of the nature of its business;
- The total number of authorized shares, itemized by class and series, if any, within each class; and
- The total number of issued and outstanding shares, itemized by class and series, if any, within each class
How do I determine if the Corporate Name I want to use is available?
The office of the Secretary of State will make a determination of name availability for Corporate Entities in response to written requests. There is generally a small fee. If you wish to reserve a Corporate Name for a Business Entity, most States will allow you to do so after the completion and filing of the appropriate form(s) generally entitled “Application for Reservation of Name.”
If I incorporate, will anyone else be able to use my chosen Corporate Name?
Issuance of a name by the Secretary of State does not necessarily give a person the exclusive right to use that name. Many businesses do not choose to incorporate. A Secretary of State's office generally has no record of these and thus cannot search names of unincorporated businesses.
Is there a minimum age for Officers of a Corporation?
Most States do not have a minimum age requirement but do require that Members of the Board of Directors must be at least eighteen (18) years of age.