The Importance of Business Succession Planning

Business owners start businesses for a variety of reasons.  They have discovered or created a great new product.  They might have felt they could do a better job of providing a service.  Some business are born out of necessity after a layoff.  What ever the reason for formation all businesses have one common future, the person who started the business will leave the business.

While this departure sometimes occurs as a result of the business failure.  Many times it is by choice when the business owner retires or decides to pursue other goals.  The first choice doesn’t provide many options but the second is full of options.

A few options include a move into new ownership, new management with existing ownership or close the doors.  More important than what option is chosen is the proper preparation to effect the change.  This preparation should involve a team of experts to help the owner understand the implications of each of their options and then chart a path.  The foundation for the team is an attorney and a tax professional. The team may need to include business valuation experts, business brokers and insurance agents.

As with all planning, the earlier you start the better the outcome.  Ideally, within a year of start up the owner should have a general idea of their long term goal.  Do you want to build a business that can be sold?  Do you want to build a business for their children to work in and eventually take over?  Do you want to work until they retire and then just close the doors?  The end goal may direct the decisions for how the company grows and develops.  Naturally this plan should be review because the desires and needs of the owner may change over time.

If the plan is to transfer ownership by sale or sweat equity, a plan should be developed and implemented at least 3 -5 years before the actual event is scheduled to take place.  Having a plan in place can build the value of the business.  It can also  protect the value of the business from an unexpected death or disability.

Classification of Your Workers as Employees or Independent Contractors

The IRS is very interested in whether companies have properly classified their workers as employees or independent contractors.  Why? Because if an individual is classified as an employee, he or she is subject to federal income tax and employment tax withholding when the wages are paid. This means the government gets their tax money right away.  Wages and taxes withheld are reported via the Form W-2.

If an individual is classified as an independent contractor, the government isn’t guaranteed to get its federal income tax – the service recipient would have to report the income on a Form 1099 and the worker would have to report the income.

The IRS sees this as a big problem.  Not all companies report income paid to independent contractors on a Form 1099 and not all independent contractors report income earned on their income tax returns.

How does a company know if a worker is an employee or an independent contractor?  This is a very complicated area, and there is no hard and fast rule.  Each situation must be reviewed to determine whether, based on the facts and circumstances, a worker is an employee or not.

The common law says that a worker is an employee if the service recipient (the company) has the right to control and direct the service provider (the worker).  The control is not only over the results of what is to be accomplished, but also how the result is accomplished.

The IRS has relied on a 20 factor test to weigh how a worker should be classified.  These factors generally fall into three categories:

  • Behavioral Control
  • Financial Control
  • Relationship of the Parties

An analysis of all of these factors is outside the scope of this blog post.  You should contact your attorney or accountant to help you determine the proper classification of your workers.

Estate Planning for Business Owners

Business owners like all individuals should start with the basics. There are four documents that form the cornerstone of all estate planning. They are a will, durable power of attorney, medical power of attorney and directive to physician (living will). Non-traditional families and same sex couples should consider some additional documents to provide similar coverage available to married couples under the law.

Business owners have unique needs beyond that. They need to protect their business also. This may include preparing for a transfer to a known or unknown future owner. It could also provide for the smooth dismantling of the business. Providing for either circumstance will remove a burden from the loved ones left behind.

Many business formation documents will address what is to happen in the case ofdivorce, disability or death. But these documents should be reviewed regularly to see if they address all potential scenario’s and if the solutions are still viable. If your business formation documents do not address these issues then you must consider whether to modify your formation documents or address these issue in your will.

Using your will to define how to transfer or wind up your business can resolve any issues not addressed in the formation documents. Addressing these issues in your will can be easier than modifying formation documents in some cases. However, it is also important to ensure someone has authority to run the business if you are disabled.

Business owners should work with an attorney to ensure they have an estate plan designed to meet their unique needs. Proper planning will allow you to protect those you leave behind and ensure you leave the legacy you desire. Every business owner has a dream for the future of their business don’t let poor planing derail that future.

Issues to Consider When Forming a Limited Liability Company

When you create an LLC you are creating an entity that is completely separate from the owners who are called members.  The LLC will continue to exist until dissolved.  The LLC combines many of the strengths of both corporations and partnerships.  The members have liability protections similar to a corporation.  They are shielded from liability for the LLC’s debts, obligations and liabilities.  However, they have the benefit of partnership type federal tax treatment.

One of the first decisions to be made is the name of the business.  When forming as an LLC you must include Limited Liability Company, Limited Company or an abbreviation of one of these in the name of the business.

It is important to be familiar with any state or local requirements for the business you intend to run.  Are there professional license requirements that exist?  Hairdresser, employment agency or real estate agent are just a few of the businesses that have licensing requirements.  You will also need to check with the city for any permits that are required.  For example, a restaurant will need a permit from the local health department and a liquor license if they offer alcoholic beverages.

If the business will be involved in transactions that are subject to sales tax the seller must obtain a sales and use tax permit.  The margin tax became law effective 1/1/08 replacing the franchise tax.  With the margin tax there is a presumption of taxability.  Sole proprietorships, general partnerships owned by natural persons, and certain non-profit and investment entities are excluded from the tax.  The margin tax is a tax on the gross profit margin of the business.

A discussion with an attorney and CPA will help determine if an LLC is the best structure for your new business.

Small Business Owners Should Plan for the Three D’s

You form a partnership with a business colleague.  Everything is going well, business is growing and life can’t get any better.  Then your business partner’s husband asks for a divorce.  Does your partnership agreement address the issues relating to the divorce of a partner?  What if your partner is your spouse and they have asked for a divorce?

You are running a successful business as a sole proprietor.  Driving home from work you are injured in an automobile accident and will need several weeks to recover.  Will your employees be able to continue in your absence?  Could your spouse, beneficiaries or employees easily continue or wind up your business if the accident had been fatal?

Whatever your business structure your business plan and managing documents should address these unpleasant possibilities.  While the following is not an exhaustive list having an answer to these key questions will get you well on the way to planning for the three D’s.

DISABILITY

Consider your key job functions.  Is anyone else currently trained in some or all of those functions?  If not, why not?  Consider the answer to this question carefully.  If no one is cross trained because there is not enough time or you didn’t think it was important, perhaps you should reconsider.

If you have security concerns consider a method that employs two or more people in your absence.  For example, checks that require two signatures so that two key employees or an employee and a trusted family member or friend must sign the checks.  If you have a CPA or bookkeeper perhaps they could step in to cover your accounting functions until you return.

Do you have a senior staffer capable of managing employees, overall business supervision and basic business decision making?  If you are a one man shop, is there someone in a related business that you could partner with to cover for each other in emergency situations?

DIVORCE

Does your managing agreement address what happens if someone is getting divorced?  Does your plan define who owns the stock, is a member of the LLC or is a partner in the partnership?  Have you defined a method for one party to buy out another?  If allowing a divorced spouse to own a portion of the business is unavoidable have you addressed voting rights and decision making?

If the divorce is happening within the company management will the business continue?  If so, which party has the right to stay in the business?  What rights does the person leaving the company have to reimbursement for their share and efforts in building the company?

DEATH

The key question here is can the business exist without you or are you the business?  If you are the business, then your planning should make it easy for those left behind to resolve unfinished work, collect unpaid bills and perform the other functions necessary to wind up your business.

If your business can exist without you and you wish to make that legacy an option.  Start by reviewing the issues raised in the disability section.  Do you have a clear succession plan?  Who is to step up and take over your job if you have passed?  Does that person know?  Are the properly trained?

 

Planning for the three D’s requires a great deal of thought and some difficult decisions but your business will be the better for your planning.

Issues to Consider When Forming a Partnership

Selecting your business structure is one of the most important decisions you will make.  You should take the time to consider all of your options before selecting a business structure.

There are several types of partnerships available to business owners.  A partnership is created anytime two or more people come together to conduct business for profit.  Partnerships are governed by partnership agreements and each partner is taxed on his or own share of the income. The partnership agreement controls every aspect of the business according to its terms unless it conflicts with a few statutes that the state requires.  One such statute requires all partners have access to the partnerships books and records.

A general partnership is the default if two or more people enter into business together with no formation documents. A general partnership can be created by design as well. This is the easiest form of partnership to create and carries the greatest risk to its members. All general partners are liable for the debts and liabilities of the partnership.  This liability includes responsibility for the wrongful acts of other partners.

A limited partnership (LP) has general partners and limited partners.  The general partner is subject to all the risks of partners in a general partnership unless the general partner is a corporation of limited liability company.  The limited partner is an investment partner only and cannot participate in the management of the partnership.

A limited liability partnership (LLP) is not really a separate type of partnership it is a subset of the LP.  An LLP offers some liability protection to the partners from the wrongful acts of the other partners.  The LLP must file annually with the state to maintain this status.  An LLP is required to carry specific amounts of liability insurance.  These partnerships must include one of the following or its abbreviation in the name; registered limited liability partnership (RLLP) or limited liability partnership (LLP).  All partners in an LLP can participate in the management of the partnership.

When beginning any business it is important to be familiar with any state or local requirements for the business you intend to run.  Are there professional license requirements that exist?  Cosmetologists, hairdressers or real estate agent are just a few of the businesses that have licensing requirements.  You will also need to check with the city for any permits that are required.  For example, a restaurant will need a permit from the local health department and a liquor license if they offer alcoholic beverages.

If the business will be involved in transactions that are subject to sales tax the seller must obtain a sales and use tax permit.  The margin tax became law effective 1/1/08 replacing the franchise tax.  With the margin tax there is a presumption of taxability.  Sole proprietorships, general partnerships owned by natural persons, and certain non-profit and investment entities are excluded from the tax.  The margin tax is a tax on the gross profit margin of the business.

Issues to Consider When Choosing to Incorporate

Selecting your business structure is one of the most important decisions you will make.  You should take the time to consider all of your options before selecting a business structure.

When you create a corporation you are creating an entity that is completely separate from the owners and shareholders.  The corporate entity will continue to exist until dissolved.  It is this separate entity status that provides the protection to shareholders from corporate debts and liabilities. This liability protection is often the primary reason for selecting incorporation.

One of the first decisions to be made is the name of the business.  When forming as a corporation you must include Corporation, Company, Incorporated or an abbreviation of one of these in the name of the business.

It is important to be familiar with any state or local requirements for the business you intend to run.  Are there professional license requirements that exist?  Hairdresser, employment agency or real estate agent are just a few of the businesses that have licensing requirements.  You will also need to check with the city for any permits that are required.  For example, a restaurant will need a permit from the local health department and a liquor license if they offer alcoholic beverages.

If the business will be involved in transactions that are subject to sales tax the seller must obtain a sales and use tax permit.  The margin tax became law effective 1/1/08 replacing the franchise tax.  With the margin tax there is a presumption of taxability.  Sole proprietorships, general partnerships owned by natural persons, and certain non-profit and investment entities are excluded from the tax.  The margin tax is a tax on the gross profit margin of the business.

One of the drawbacks to forming a corporation is that corporations must pay taxes on their profits.  This creates a double taxation situation that is quite noticable to the small organization.  One way to address this is with an S corporation election.  This result is the corporation will be taxed under partnership rules.  The corporate income is allocated to the shareholders and taxed on their individual tax returns.

There are disadvantages to electing S corp status.  Converting from an S corp or distributing property from an S corp are both taxable events.  S corps are not allowed to allocate income, deduction, gain or loss among their shareholders.  S corps are also limited in the number and types of shareholders they can have.

A discussion with an attorney and CPA will help determine if a corporation is the right step for your new business and whether you should consider the S corporation election.

Four Basic Business Entities

Sole proprietor is the easiest business to start.  This requires nothing but that you begin providing a product or service and you must file an assumed name certificate in the county where you will be working. While this is the easiest form it has no liability protection at all.

Partnership is a business structure that includes two or more people. If no formation papers are filed with the secretary of state what is created is a general partnership.  A general partnership is the default business structure of two or more people providing a product or service.  You must file an assumed name certificate with the county were you will be working.  There is no form of liability protection for the members of a general partnership.

If you file formation papers with the secretary of state you can create a a limited partnership or a limited liability partnership.  A limited partnership must included the name limited or limited partnership or the abbreviation of either in its name.  There is some liability protection in this form of partnership.

A limited liability partnership must include in the name either limited liability partnership or the abbreviation LLP.  In addition to filing formation papers with the secretary of state, the partners have annual filing requirements.  An LLP has additional insurance requirements to satisfy as well.  There is liability protection in this form of partnership.

Corporations must file formation papers with the secretary of state.  The company name must include corporation, incorporated, company, limited or an abbreviation of any of these.  There is no limitation on the number of people or entities that can own a C corp.  However, there are limits on S corp ownership.  There are additional differences between C and S corp status that will be discussed in a future blog entry.  There is liability protection in this business form.

Limited Liability Companies must file formation papers with the secretary of state.  The company name must include limited liability company or limited company or an abbreviation of either.  This business form combines many of the benefits of corporations and partnerships and blend them into a new entity.  There is liability protection in this business form.

There are tax implications to each of these business types that is outside the scope of this blog entry.  This will be addressed in future entries that provide in depth coverage of each business entity.