Editor's Note: Here’s an excerpt from Succession Planning: Step-by-Step. Go here to read more. 

A sound dealership succession plan addresses a long list of issues, including retirement income, transferring wealth to the dealer’s heirs, transferring ownership, dealing with the income and estate tax consequences associated with an ownership transfer, and addressing other issues key to the ongoing success of the business; not the least of which (and often forgotten) is transitioning management.

Step 1: Identify and prioritize goals for the transition.

Step 2: Identify and prepare new management. 

Step 3: Determine retirement cash needs

Step 4: Review options for funding the transfer

Step 5: Planning for Ownership Succession

For purposes of discussion, ownership succession can be viewed from two distinct perspectives: transfers to a family member or members and transfers to non-family members. 

Transfers to Family Members

You can hardly overstate the impact of family dynamics on transferring ownership to a child or children. Beyond business, the transfer involves emotion. While the role of a succession advisor is key to properly transferring ownership under any circumstances, an experienced advisor can be particularly helpful in addressing issues that arise when ownership will remain within the family. The succession plan should serve to:

Divide ownership between active and non-active family members. Some dealers want to divide their estate evenly among their children, but the children within a dealer’s family typically will have different abilities and degrees of interest in the dealership. Equal and fair are seldom the same in such a scenario.

It is better to transfer other assets to non-active children, reserving the dealership for the sibling who is active in the business and, most significantly, demonstrates the skills to run a profitable operation. We often recommend using various types of insurance to equalize the dealer’s estate between active and non-active heirs.

Help children active in the business acquire interest in the business. Insurance is only one vehicle for helping active children acquire the business at an owner’s death, but, it can be a useful one. Life insurance can provide the proceeds required to buy the business. There are useful and appropriate roles for life insurance trusts, second-to-die policies and other insurance vehicles, but it is not always a go-to solution.

Succession planning should begin well before a dealer reaches retirement age. If planning is done early, gifting or other tax-effective methods can be used. 

Help a dealer understand the pitfalls in transferring ownership to inactive children. Inactive children can serve to undermine the effectiveness of siblings active in the business. Two non-actives can out-vote the active child if ownership is equally divided among the three. It is best to transfer other non-dealership assets (or a minority interest at most) to inactive children and keep control in the hands of actively involved siblings.

If minority interests are given to the non-active children, there can be a downside for them. This downside is a non-marketable and non-income producing asset if the majority owner decides not to make income distributions to minority owners. Planning can help avoid such problems. 

Help craft a buy-sell agreement. If a buy-sell is an appropriate succession planning tool, then it must be written so that the provisions produce the desired leadership, economic and tax results. 

Transfers to Non-Family Members

Dealers not passing along their business to a family member might sell to a neighboring dealer or a public or private equity group. Where there are multiple owners, transition can occur inside the ownership circle, a “friendly” if not a family transfer. The advisor’s role can be:

To determine the provisions in a buy-sell agreement that will serve to keep ownership among the existing partners, if that is desired.

To locate a buyer when no obvious successor is in sight. Often, employees are willing to buy the dealership, but lack the assets to make the purchase. When an owner must finance part of the purchase, it is critical that the buyer has the ability to operate the dealership profitably and the commitment to ongoing payments is secured.