Business Succession Planning for Small Business Owners in Texas

Serving Clients in Houston and the Surrounding Area

Family businesses are the backbone of the American economy. According to various estimates, family-owned businesses account for approximately 90% of all business enterprises in the United States. One-third of Fortune 500 companies are family-controlled, and family businesses collectively generate an estimated $10.4 trillion in annual revenue. These businesses provide jobs, support communities, and represent the life’s work of the founders who built them.

Yet despite their importance, the vast majority of family businesses do not survive beyond the founding generation. Studies consistently show that only about 30% of family businesses survive into the second generation, 12% into the third, and just 3% into the fourth generation and beyond. The reasons for this high failure rate are well-documented – and largely preventable with proper planning.

Why Family Businesses Do Not Survive

The failure of family businesses to survive across generations typically comes down to three factors: people, taxes, and cash.

People. Family dynamics are complicated, and they become even more so when money and business decisions are involved. Sibling rivalries, generational differences, in-law conflicts, and disagreements about the direction of the business can tear families apart. Without a clear succession plan that addresses leadership, ownership, and decision-making, these conflicts often prove fatal to the business.

Taxes. The transfer of a business from one generation to the next can trigger significant estate and gift tax liabilities. Without proper planning, the tax bill can be so large that the family is forced to sell the business – or significant portions of it – just to pay the IRS. This is particularly true for businesses that are asset-rich but cash-poor.

Cash. Even when taxes are manageable, the transfer of a business often creates liquidity problems. The business may be the family’s most valuable asset, but it cannot easily be divided among multiple heirs. Without sufficient cash or other liquid assets to equalize distributions, fund tax obligations, and provide for non-business heirs, the transition can fail.

Family Business Owners and Estate Planning

For family business owners, estate planning is not optional – it is essential. A comprehensive estate plan for a business owner must address not only the traditional concerns of wills, trusts, and powers of attorney, but also the unique challenges of transferring a business to the next generation. This includes identifying and developing successor leadership, structuring ownership transfers in a tax-efficient manner, and ensuring that the business has the resources it needs to continue operating during and after the transition.

Estate Tax Uncertainty

One of the greatest challenges facing family business owners is the uncertainty surrounding the federal estate tax. The Tax Cuts and Jobs Act of 2017 temporarily doubled the estate tax exemption, but that increased exemption is scheduled to sunset at the end of 2025, potentially cutting the exemption in half. This uncertainty makes planning difficult, but it also makes planning more important than ever. Business owners who wait until the law changes to begin planning may find that it is too late to implement the strategies that could have saved their families millions of dollars in taxes.

Coordinating Financial and Estate Plans

A business succession plan cannot exist in isolation. It must be coordinated with the business owner’s overall financial plan, including retirement planning, investment strategy, and insurance coverage. The goal is to create a comprehensive plan that meets the owner’s personal financial needs, provides for the equitable treatment of all heirs (both those involved in the business and those who are not), and positions the business for long-term success.

The Business Buy-Sell Agreement (BSA)

A buy-sell agreement is one of the most important tools in business succession planning. It is a legally binding contract that governs what happens to a business interest when an owner dies, becomes disabled, retires, or otherwise leaves the business. A well-drafted buy-sell agreement provides a predetermined mechanism for transferring ownership, establishes a fair price for the business interest, and ensures that the transition occurs smoothly.

There are several types of buy-sell agreements, each with its own advantages and disadvantages:

Entity Purchase (Redemption) Agreement

In an entity purchase agreement, the business itself agrees to buy back the departing owner’s interest. The business is the buyer, and the departing owner (or their estate) is the seller. This structure is straightforward and works well for businesses with multiple owners, as it does not require the remaining owners to come up with the purchase price personally.

Cross-Purchase Agreement

In a cross-purchase agreement, the remaining owners agree to purchase the departing owner’s interest directly. Each owner buys a proportionate share of the departing owner’s interest. This structure can provide tax advantages, as the purchasing owners receive a stepped-up basis in the acquired interest. However, it can become complex when there are multiple owners, as each owner must maintain separate insurance policies or funding mechanisms.

Wait-and-See (Hybrid) Agreement

A wait-and-see agreement combines elements of both entity purchase and cross-purchase agreements. It gives the parties the flexibility to decide at the time of the triggering event whether the business or the remaining owners will purchase the departing owner’s interest. This flexibility allows the parties to choose the structure that provides the greatest tax and financial advantages under the circumstances that exist at the time.

Funding a Buy-Sell Agreement

A buy-sell agreement is only as good as the funding behind it. Without adequate funding, the agreement is just a promise – and promises do not pay for business interests. The most common funding mechanisms include life insurance (which provides immediate liquidity upon an owner’s death), disability insurance (which provides funds if an owner becomes disabled), and installment payments (which allow the purchase price to be paid over time). Life insurance is by far the most popular funding mechanism, as it provides a known amount of cash at precisely the time it is needed most.