Connelly vs United States and Succession Planning

The recent Connelly v. United States Supreme Court decision provides critical insight for closely held business owners considering succession planning and tax implications.

The Court's ruling clarifies that life insurance proceeds owned by a corporation, even if intended for share repurchase agreements, increase the corporation's value for estate tax purposes. This decision impacts business owners who use corporate-owned life insurance as part of their succession planning, as it reaffirms that the company's obligations to redeem shares do not reduce the company's valuation in terms of tax liability.

Key Takeaways from Connelly v. United States

1. Business Value Impact: Life insurance proceeds payable to the corporation increase the corporation's valuation, which affects the value of shares for estate tax calculations. In Connelly's case, the $3 million policy proceeds were added to the company's value upon Michael's death, which led to a substantial tax bill.

2. Planning Options: The Court suggested alternative structures, like a cross-purchase agreement where individual shareholders own policies on each other. This setup may avoid increasing the corporation's value upon a shareholder's death, potentially reducing estate tax exposure.

3. Professional Advisory Importance: This case underscores the value of consulting with tax professionals, insurance experts, and succession planners to design strategies that align with tax laws, which can help mitigate unexpected financial consequences.

Practical Steps for Business Owners

• Coordinate with your Advisory Team: Using a coordinated approach with legal, tax, and insurance professionals can ensure strategies align with tax regulations, reducing the risk of unintended tax liabilities.

• Consider Cross-Purchase Agreements: Cross-purchase agreements may provide tax advantages over corporate-owned life insurance policies for some businesses.

Connelly v. United States offers a valuable lesson in how business structure and tax planning interact. Proactively structuring ownership transitions could avoid similar tax outcomes, enabling smoother family business successions and a more straightforward path for future growth.

Contact us today for assistance in reviewing your current agreement: 301-859-0860 | email@ennislp.com.

Challenges Faced in Moving from Founder Mode to Manager Mode

Transitioning from founder mode to manager mode presents several challenges for small business owners as they plan for their eventual exit. Different leadership styles and approaches will be required as the business grows and moves from the start-up phase to a more mature stage. Here are some key challenges associated with this transition:

1. Letting Go of Control

• Challenge: Founders are used to being involved in every aspect of the business, from strategy to daily operations. Letting go of control and delegating responsibilities can be difficult, as they may feel no one else understands the business as well as they do.

• Impact: The reluctance to delegate can lead to micromanagement, slowing decision-making and growth. It can also create bottlenecks, as the founder becomes overwhelmed with too many tasks.

2. Shifting from Visionary to Operational Focus

• Challenge: Founders typically excel in setting a vision, driving innovation, and taking risks. However, manager mode requires focusing more on operations, process optimization, and day-to-day execution, which may be less exciting for visionaries.

• Impact: Founders may struggle to pay attention to detail, follow structured processes, or deal with routine tasks, which are crucial to managing a growing company. This shift from creativity to structured management can be frustrating.

3. Building and Leading a Structured Team

• Challenge: In founder mode, the team is often small, agile, and close-knit. As the company grows, roles must be formalized, a leadership team must be built, and clear organizational structures must be implemented.

• Impact: Founders may find it challenging to hire the right people for specialized roles, trust them to lead, and give up the hands-on approach. Moving from managing a few people to leading a large team with hierarchies requires different communication and leadership skills.

4. Process and System Implementation

• Challenge: Startups often thrive on flexibility and improvisation, with founders and employees solving problems as they arise. Creating consistent processes, implementing systems, and formalizing workflows in manager mode are necessary for scalability.

• Impact: Founders may resist implementing formal processes, viewing them as bureaucracy or fearing they will stifle creativity and agility. However, the company can experience inefficiencies, errors, and miscommunication without systems.

5. Balancing Innovation with Efficiency

• Challenge: In the early stages, the focus is often on experimentation and rapid growth. However, as the business matures, the emphasis shifts to sustaining and improving existing operations, which can slow down innovation.

• Impact: Founders may feel restricted by the need for stability and consistency, leading to frustration or the fear that the company is losing its edge. They must learn how to innovate within a more structured environment and balance exploration with exploitation of existing resources.

6. Changing Decision-Making Approach

• Challenge: Founders are often comfortable making fast, instinct-driven decisions, especially in a startup’s early, chaotic phase. However, manager mode requires a more data-driven, systematic approach to decision-making, with input from multiple stakeholders.

• Impact: This change in pace can be frustrating, as it may feel slow or bureaucratic. Founders may also find adjusting to consensus-building and decision-making processes involving multiple teams or departments difficult.

7. Evolving Leadership Style

• Challenge: In the startup phase, founders often lead by example, working alongside their small team and wearing many hats. In manager mode, leadership requires more delegation, coaching, and empowering others to make decisions.

• Impact: Founders may struggle to evolve from a hands-on leader to a coach and mentor. Some may find it difficult to trust others to lead parts of the business they once controlled, or they may lack experience managing at scale.

8. Cultural Shifts

• Challenge: As a company grows, its culture evolves. A startup's casual, entrepreneurial culture may give way to a more formal environment with policies, procedures, and defined roles.

• Impact: Founders may struggle to preserve the original culture while adapting to the needs of a larger, more structured organization. If this transition is not managed carefully, it could alienate early employees or create cultural friction.

9. Increased Accountability and Reporting

• Challenge: As a business scales, there is a greater need for accountability, both internally (to employees and managers) and externally (to investors, customers, and regulators). Regular reporting, budgeting, and performance tracking become critical.

• Impact: Founders may find these new demands tedious or at odds with their entrepreneurial spirit. Learning to appreciate and manage financial statements, compliance, and performance metrics is essential but often feels like a departure from the freedom they once had.

10. Adapting to a Slower Growth Rate

• Challenge: Growth can be rapid and exhilarating in the startup phase. However, as the business matures, growth typically slows, and the focus shifts from rapid expansion to sustainable profitability and market share maintenance.

• Impact: Founders may struggle with the psychological shift from chasing hyper-growth to being content with incremental improvements. This can lead to dissatisfaction or impatience, as they may feel the business has plateaued.

11. Navigating Investor or Board Expectations

• Challenge: In manager mode, founders often have to deal with external stakeholders like investors or a board of directors who expect regular updates, transparency, and a focus on profitability and governance.

• Impact: Founders may feel constrained by these expectations and struggle with the shift from independent decision-making to being accountable to others. The pressure to meet financial targets and adhere to corporate governance can be overwhelming.

12. Emotional and Psychological Shift

• Challenge: Moving from founder mode to manager mode often requires founders to redefine their role within the company, which can lead to an identity crisis. They may feel like they are no longer driving the company’s direction or being pushed out of what they built.

• Impact: This emotional transition can result in burnout, loss of motivation, or frustration. It can also cause tension between the founder and other managers or team members, especially if the founder resists stepping back.

How to Overcome These Challenges:

• Hire Experienced Managers: Bringing in professional managers with expertise in operations, finance, and HR can help bridge the gap between founder and manager modes.

• Delegate and Trust: Learning to delegate and trust the team is essential. Founders should focus on empowering others to take ownership of critical areas.

• Focus on the Big Picture: As the company matures, founders should focus on long-term strategy for growth and exit, vision, and leadership while letting managers handle day-to-day operations.

• Develop a New Leadership Style: Founders must evolve from hands-on involvement to coaching, mentoring, and strategic guidance.

• Accept the Need for Structure: Embrace the importance of processes, systems, and data-driven decision-making to ensure long-term sustainability and growth.

This transition can be difficult, but successful navigation allows the founder to play a pivotal role in scaling the business while adapting to the new challenges and opportunities that come with a more mature company.

We can help you overcome these founder challenges, strengthen your management team, and train and equip your successor(s). Contact us today for an exploratory conversation at email@ennislp.com or 301-859-0860.

What Are The Key Steps in Creating My Business Exit Strategy?

Creating a business exit strategy involves planning and preparation.

Planning for your eventual transition is a significant undertaking with much at stake. It can take years of planning and preparation to execute a successful plan.

Following are some critical elements to consider when developing your exit strategy:

1. Establish Your Goals and Objectives: Clarify your personal and financial goals for exiting the business. Are you looking to maximize the financial return, ensure a smooth transition, preserve the legacy of the business, or prioritize your well-being? Identifying your objectives will help guide your decisions throughout the exit process.

2. Timing: Determine the ideal timeline for your exit. Consider factors such as market and industry conditions and trends, business performance, personal circumstances, and any external events that may impact the timing of your departure. It is essential to give yourself enough time to prepare the business and maximize its value.

3. Valuation: Conduct a thorough business valuation to determine its worth. Engage the services of a professional business valuation specialist to assess the fair market value of your business. This valuation will help you understand the financial implications of your exit strategy and assist in setting a realistic asking price.

4. Succession Planning: Decide how you want to transition ownership and leadership of the business. This could involve grooming and training a successor within the organization, selling to a third party, transferring ownership to family members, or considering a management buyout. Develop a plan for developing and preparing the next generation of leaders if you choose an internal succession.

5. Prepare the Business for Sale: Take steps to maximize the value of your business before putting it on the market. This may include strengthening essential business functions, improving financial performance, enhancing operational efficiencies, and addressing legal or regulatory compliance issues. Create accurate and up-to-date financial records, streamline processes, and improve the attractiveness of the business to potential buyers.

6. Seek Professional Advice: Establish an advisor team of experienced professionals specializing in business exits. They can guide you through the legal, financial, and tax implications of your exit strategy, provide valuable insight, and help navigate the complexities of the process.

7. Consider Tax and Legal Implications: Understand the tax consequences associated with your exit strategy. Consult with a tax advisor to explore options for minimizing tax liabilities and maximizing your after-tax proceeds. Review any legal agreements, contracts, licenses, or leases that may impact the sale or transfer of the business and address any potential legal issues.

8. Communicate and Plan for Transition: Develop a comprehensive communication plan to inform and involve key stakeholders, such as employees, customers, suppliers, and business partners, about your exit strategy. Consider minimizing any disruption during the transition and ensuring a smooth handover of responsibilities.

9. Personal Wealth and Estate Planning: Review your financial situation and ensure that your personal wealth management and estate planning align with your exit strategy. Work with a financial advisor and estate planner to address wealth preservation, retirement planning, asset protection, and estate distribution issues.

Remember, creating an exit strategy is a complex process that requires careful consideration and planning. It's essential to start early, seek professional advice, and regularly review and update your plan as circumstances change.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Seven Questions Every Small Business Owner Should Answer

A company with strong value drivers can demand (and receive) a higher multiple on the same amount of EBITDA than can a company with average value drivers.  — John Brown, The Business Enterprise Institute (BEI)

Almost all of us consider the future and invest in the stock market either directly or through retirement plans to position ourselves and our families for the inevitable future.  While the above quote refers to investing in the stock market, the principle applies to your small business.  As you look ahead to the future, every small business owner should pay careful attention to the value drivers behind the business – ensuring the business portfolio increases over time.

In their book Execution, Ram Charan and Larry Bossidy speak about successful execution as “exposing reality and acting on that reality”.  So, as you consider your business investment, ask yourself the following “Value Driver questions:

 1.         Do I have a healthy management team?   It's often been said that people are our most valuable resource. Experienced leadership, that understands the business, as well as the culture of the organization, are critical to the ongoing success of the business. This is also one of the key factors behind developing business value when it comes down to selling your business.   Cultivating these employees, and ensuring that they remain even after you sell the business is significant to the events or buyer/owner of the business

2.         How effective are my operating systems?  Human resources, personnel recruitment and training, asset control, production control, and performance reports are all the key ingredients of healthy operations within any organization. If these internal mechanics are not running well, this could have significant negative consequences on the value of the organization.

3.         Are my margins equal to or better than the industry average?  If not, what actions can will it take to get them there?

4.         How diverse is my customer base?  Having one's eggs in one basket is always a risk. Having a key single customer that has more than 10% of total sales obviously is a downside for a business. Long before being ready to sell it is helpful to take a look at this and pursue diversification.

5.         Is my facility in “ship-shape”?  - keeping our home reflects our values, and our priorities. Similarly, keeping our business facility in sharp condition reflecting professionalism and effectiveness is critical to establishing business value. It was so into an outside third party, first impressions are significant. They were plucked attention to the small details.

6.         What is my growth strategy?   The roadmap for growth needs to clearly laid out, risks identified, and goals established.  Future cash flow, value and well-being of your employees is dependent on a vision for the future codified into actionable steps.  The plan alone will not get you there, but no plan will get you no-where.

7.         Do I have control of my numbers?  At the end of the day, you need to understand the financial health of your business.

Exit planning should begin the day you start your business.  And, at the core, or center of exit planning is maximizing the value of your business.  Just as you manage the value of your 401k or investment portfolio, investing time, energy and thought into building the value of your business will position you to exit in the manner you desire.  Get started today by exposing reality and assessing your business value drivers.

Invest 12-15 minutes in the FREE ExitMap® Assessment and get a 12-page report scoring you in four key exit planning areas: Finance, Planning, Revenue/Profit, and Operations.

Preparing a Successor...How Long Does It Take?

It’s an important question to answer. The company’s future, the successor’s success, and the ability to make buyout payments depends on it.

When it comes to learning the business and the industry, an owner probably knows best as to how long that will take. Generally, this will take anywhere from 3-15 years. However, learning the mechanics of a business does not necessarily make someone a good leader nor a good owner. (After all, most successors have only been an employee.)

Clearly, some people are more natural at leading than others, but one thing is sure. We're not very good at self-assessment (especially when it comes to leadership). Assuming a successor understands the business, their effectiveness as a leader and as an owner needs to be objectively assessed and their weaknesses improved.

A leadership assessment followed by a program of executive coaching will accomplish this. After 20 years of developing leaders, I can say that the process generally takes about 6-12 months.

But a major challenge can arise. What if that successor turns out not to be competent as a leader and an owner? By way of example, years ago I had a client who kept bringing on potential successors (without my help, by the way...), only to have each of them fail. One after another (three in total), each failed and either left the company or had to be fired. Before they found a suitable successor, almost 4 years had transpired.

The bottom line is that it's better to start the leadership development process sooner than later. Don't hand over the keys to your business before your successor's competence is assessed, their weaknesses addressed, and their leadership and judgment demonstrated.

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Michael Beck is an executive coach, business strategist, author, and president of Eliciting Excellence.  His 20 years as a professional executive coach has helped leaders improve interpersonal skills, sharpen strategic thinking, and enhance judgment.  He has worked domestically and internationally with a wide range of clients from diverse industries including technology, manufacturing, professional services, healthcare, financial services, and not-for-profit.  Michael has held executive positions ranging from CEO to  VP of Business Development and has a background in engineering (BS, MS – University of Pennsylvania) and finance (MBA – Wharton School of Business). Michael is the author of the book “Eliciting Excellence”, has a Black Belt in self-defense,  and is a competitive dart player.

A Succession Plan or an Exit Plan? Savvy Business Owners Have Both!

One of the questions we often hear from business owners is, “What is the difference between Succession Planning and Exit Planning?  Aren’t they the same thing?”  Surprisingly, they are not.  The next question usually is, “Which one do I need?” The answer is simple.  Whether the business is small or large, family-owned or not, astute business owners always need both.

Nearly $10 trillion dollars in business assets will be transferred globally in the next decade, according to Forbes Magazine.  Baby Boomers selling privately owned businesses or transferring them to family members will comprise much of that $10 trillion dollar transfer.  As the market becomes crowded with owners ready to sell, the advantage will go to those owners who have done their due diligence, considered all of their options, and planned for unexpected contingencies.

Succession Planning

Succession Planning focuses solely on transferring leadership inside the business from one generation to the next.  Succession plans identify key individuals within the organization who can be trained and mentored to someday take over as the existing business leaders exit.  Succession Planning is just one necessary aspect of a more comprehensive exit plan.

Exit Planning

Exit Planning incorporates succession planning with strategies for building transferrable value, reducing tax liability, preparing for unexpected contingencies, minimizing family stresses, and increasing the likelihood of a successful business transfer.  Exit plans also incorporate the personal and financial goals of the business owner, their spouse, and their family.  A prudent exit plan starts and ends with the long term business and personal objectives of the owner.

Plan Ahead for A Successful Exit

Succession plans and exit plans so share an important characteristic – neither should wait.  Business owners who eventually want to sell for top dollar with the least amount of trouble must start the planning process early enough to give it the thought and consideration it requires.   With the proper plans in place, you, the business owner, gains the ability to make critical long-term decisions that will significantly increase the likelihood of selling or transferring the business when you want, to whom you want, and for the price you want.

Take our FREE 15-Minute ExitMap® Assessment and find out how ready you are to exit successfully.