Business Succession: Keeping Ownership In The Family
You’ve worked hard to build a successful business, and you have a great emotional stake in its future. That is why, as you begin to think about retiring, you may want to make sure the business stays in the hands of someone who has the same emotional attachment—in other words, someone in your family. But even if you don’t plan on retiring soon, now may be a good time to start thinking about your succession plan.
Fewer than one in three family businesses survives to the second generation, and a mere 12 percent survive to the third generation, according to the Family Firm Institute. Starting the succession-planning process early—preferably at least 3 years prior to retirement—not only ensures that all options will be available to you, but also helps give you peace of mind about your business’s future.
Determining The Value Of Your Business
The first step in figuring out a succession plan is determining the dollar value of your business. Only by understanding the value of your company can you make a sound judgment about which direction to go from a succession standpoint.
Often, business owners have not had a reason to formally value their business, but this is necessary because passing on control of the business involves transferring ownership of assets. The certified public accountant who already works with your business can provide a starting point for figuring out the company’s value or refer you to a business-valuation specialist.
Planning Your Exit Strategy
Next, decide how quickly you will exit the business. The further you plan ahead, the more options you will have.
If you want to gift your business to your children, there are limits to the amount you can gift tax-free each year. You may need to gift portions of the business over several years.
Choosing A Successor
You will need to designate an appropriate family member or members to take over ownership and leadership of the business. This step—one of the most important—can become a complex process fraught with emotional—and strategic—issues.
Keep in mind that lenders look more favorably on successors who have both industry and management experience, and on companies that maintain their management teams. Therefore, your decision will affect not only the relationship between family members but also the company’s ability to obtain support in the future. A financial or business advisor can work with you on selecting and grooming a successor.
Selecting An Appropriate Transfer Method
With that groundwork done, you can start to work on the mechanics of how to transfer ownership of the business. Typically, there are two main methods for accomplishing the transfer: a taxable or a tax-advantaged method.
Although it may sound obvious which is the more attractive option, the most appropriate transfer method actually depends on several factors, including your personal plans and the business’s financial situation. An advisor can help weigh these factors.
Tax-advantaged methods of transfer include the following.
- Employee Stock Ownership Plans—These involve transferring ownership of the company both to family members and to employees. ESOPs cannot be used on their own to transfer ownership wholly to family members, but they can be used in combination with other methods of transfer—such as gifting or recapitalizations—to keep majority ownership in the family.
- Gifting—This may be a good option when ownership will be transferred gradually over a period of several years, avoiding the taxes that would result from gifting a business all at once.
The main taxable method of transfer involves the following.
- Recapitalization—This means that the company takes on debt and uses the proceeds to buy the business from the owner. You (as the seller) are compensated, your family members own the leveraged company, and the future revenue of the business is expected to pay off the loan. This can be done all at once or in stages over a period of years. Generally, you will have to pay tax on the proceeds from the sale under this method of transfer.
One thing to keep in mind about a recapitalization that involves the transfer of the business to family members is that this may require some extra involvement and assistance on your part. The terms may not be the same as the terms would be on the open market to an outside buyer. It may require your personal guarantee.
Finally, make sure that members of the family who will be involved in the leadership of the business take part in the planning process as part of their preparation to take over ownership, helping to ensure a smooth transition.