The Process of Business Succession
by Dr. Heribert Warken
A successful entrepreneurial career is crowned by a successful business transfer. According to a study by the IfM Bonn, approximately 190,000 businesses are expected to be transferred between 2022 and 2026; most of these will be in Bavaria, Baden-Württemberg, and North Rhine-Westphalia. When attempting to structure business transfers, there are essentially only three options.
Either the company will on
a) descendants,
b) employees who already work in the company, or
c) An “EXIT” is made; i.e. the company is either sold or the business activities are discontinued.
But how do I actually begin such a succession process? What is the logical sequence of steps and timeline? What must a person consider when he or she wants to embark on this process?
A succession process usually goes through four phases:
1. Phase: Assessment of the current situation
Family law assessment
In the first phase, an initial assessment must be conducted. The first step in this process is a “family law assessment”. This assessment focuses on powers of attorney and directives. One issue that is often overlooked in practice is the “power of attorney for the role of shareholder”. Generally, there are powers of attorney for the day-to-day operations of the business, but powers of attorney specifically for the role of shareholder are extremely rare. In certain cases, this can have very unpleasant practical consequences if, for example, a shareholder is temporarily unable to make declarations of intent due to an accident.
This area also covers the topics of durable power of attorney and advance healthcare directives, and, last but not least, last wills and testaments. I know that the topic of dealing with one’s own death makes most people uncomfortable; however, it puts your business and family at risk if you, as an entrepreneur, fail to address it.
Creating an emergency file
There are many important documents needed in an emergency, but where are they? Typically, important documents are scattered across different locations in various folders. It’s also very common for only the business owner to have a complete overview of the important documents and where they can be found.
However, if this information isn’t available in an emergency, it can be difficult for third parties. An emergency folder – where all important and essential information is compiled – can help here.
You can find a sample table of contents here, which can be customized to fit your specific circumstances.
This emergency folder enables a knowledgeable third party to gain an overview of all important matters within a reasonable amount of time, thereby saving a great deal of time and hassle. In addition, you’ll often make your spouse happy, as this provides them with a sense of security they typically didn’t have before.
Asset inventory
The emergency folder can now also be used as a guide for conducting an inventory of assets and liabilities. This asset inventory also plays an important role in your own estate planning considerations. Who should receive what, when, and how? Often, people are no longer fully aware of certain asset or debt positions or don’t even know their current status. The asset inventory serves to provide you with a clear overview and will likely be needed again in the not-too-distant future as part of a potential estate tax assessment anyway.
Business Valuation
The business is generally the most valuable asset involved in succession planning. Therefore, the first thing you need to know is: How much is my business actually worth? While you might be able to get a rough estimate by doing some research online, you’ll need a professional business valuation anyway when transferring ownership – including for tax reasons – so you should seek qualified expert assistance.
2. Phase: Family strategy
Once the factual assessment has been completed, the most important part begins: the emotional aspect of succession. Who is able and willing to take over the business? How can and should the remaining assets be divided? These are questions that need to be addressed.
It’s also important to involve family members in these discussions. I’ve often seen entrepreneurs make succession decisions from their “ivory tower” – decisions that were understandable from a practical standpoint but unfortunately didn’t work out because they didn’t take the other person’s wishes into account. And as a business owner, please always keep in mind when making decisions that your children perceive you and your statements first and foremost as coming from Dad or Mom, and not as those of the business owner. Often, many things go unsaid because the children don’t want to appear ungrateful, even though they may have a different opinion or their own plans.
It is important here to foster a culture of open communication, both in one-on-one conversations with each child and within the family as a whole.
In my experience, the agreements and arrangements resulting from this phase are significantly more binding for the next generation than any last will and testament, and they also help resolve “questions of interpretation”, since the parents’ intentions were discussed collectively.
If the succession involves multiple children in the business, guidelines for corporate governance should also be developed jointly at an early stage.
3. Phase: Preliminary restructuring
It is often necessary to carry out tax restructuring in advance of a succession. And this is precisely where it is important to build in a time buffer. This may involve obtaining a binding ruling from the tax office to ensure legal certainty. It also involves necessary registrations or transfers of ownership for real estate or companies. Notaries are often required. Appointments with multiple specialists must be coordinated. This isn’t possible if you’re under time pressure and need to have everything settled by tomorrow.
That’s why you should start early enough! Depending on its complexity, the transfer of a medium-sized business typically takes between 6 months and 2 years. And if you start too late, life will punish you for it.
4. Phase: Implementation and fine-tuning
Once the necessary preliminary structuring has been completed, the business can now be transferred in a legally and fiscally sound manner, and the matters discussed within the family can be implemented accordingly.
However, recent years in particular have taught us that even a fundamentally well-thought-out plan may need to be reconsidered and adjusted in light of new external factors. Here, too, you must remain open-minded and discuss matters with all stakeholders.
