Keeping it in the Family: What to Consider

 

As a business owner and parent, the idea of your children running your business may fill you with excitement and pride. It’s a laudable goal—let’s talk about how to pursue it.

Develop a Long-Term Plan

Running a business is challenging. You know because you’ve been doing it for years. Think of all the lessons you learned (and mistakes you made) as you grew into the business leader you are today. You can’t reasonably expect the next generation to take over where you left off without learning their own lessons and making their own mistakes.

 

If you’re planning to transition your business, you need to set clear expectations for how your child (or children) will gain experience and build trust with the people they’ll grow to manage. You also need time to enact the plan: expect this to take at least five to ten years.

 

Have your children take on different roles within the business, with progressively more responsibility. Put together a formalized development plan with concrete steps and timelines for role transitions. Consider having your children get an accounting degree or an MBA to formalize their knowledge and supplement their on-the-job training.

 

A development plan that’s reviewed regularly and that includes benchmarks shows that you take your children’s growth into responsibility seriously. This is important. As part of the process, you must also slowly relinquish control. After all, your ultimate goal is for the business to run smoothly without you.

 

In fact, experts often see failed business transitions when the older generation refuses to meaningfully give up leadership and the younger generation checks out or loses interest in the business entirely. A slow, planned transition makes this much easier for both parties.

The Overall Legacy for Your Family

You want to leave a legacy for the next generation, and your business is part of that. But how do you square that when you have multiple children with differing interests? Or if you have several businesses or a variety of assets that you’ll ultimately pass on.

 

“If you have one child and that child wants the business, the whole process is very straightforward. For most people, life is messier than that,” said John Gregg, 1834 Wealth Advisor.

 

The number of possible family-and-asset permutations is nearly limitless. Talking through details now makes sense, because undiscussed legacies can result in feelings of unfairness amongst your children. 

 

For example, maybe you have three children and only one of them has any interest in the business. Rather than trying to divide the business up, maybe the child who will run (and own) the business is gifted that as their legacy, while the other two are bequeathed other assets of yours in your will, so that the overall values of each are equivalent—and so that no resentment builds.

 

Talk through what you want, as well as what your children want, and how you can get there.

 

“Sometimes the only major asset is the business,” said Gregg. “If not all the children want to run it, you can possibly set up an arrangement where one child runs it and has controlling interest, while your other two children have a minority interest that includes regular distributions. This could allow you to keep the business in the family, while giving the children who would prefer liquid funds access to that.”

 

These are just two possible examples, however. Work with your entire financial team—and your children—to review your assets, how you plan to distribute them and what techniques, tools and timelines are in play. This allows you to explore financial possibilities and address any smaller issues before they become bigger problems.

Will This Be a Gift or Sale?

“In most situations, when you’re talking about passing on a business to family, we see gifting scenarios, but not always,” said Gregg.

 

There are several situations where gifting doesn’t make sense—or is not possible. For example, your business may include shareholders who find the idea of gifting unpalatable, so a sale is necessary to pass on ownership to the next generation.

 

Or, you may have one child who dearly wants the business and offers to buy it. This is okay with your other children, provided the buying child pays fair value. And, maybe in this instance, each of your children’s inheritances remain untouched, since the business was bought—and that works for everyone. 

 

Or, maybe you want to sell the business on principle. You built it and you earned the right to cash out, after all.

 

Whatever the reason, if you do want to cash out, some of the simplest options include an outright sale plus an installment package, so you get some funds immediately, with further amounts coming. Or your child could pursue financing to fund the full purchase price. 

 

Another thing to consider: Will you need to draw income from the business? Even if you want to gift the business, you could still serve in an advisory role for several years after the transition. For example, maybe you set up a 5-year consulting agreement, where you’re paid regularly and you offer your advice and experience to the next generation.

 

Whatever your situation is, deciding how you want it to pass on will inform your next steps.

Preparing Your Business to Sell

Before you sell, make sure your business is running smoothly and is worth top dollar. Work with a consulting firm specific to your industry to review all your practices and get suggestions for enhancing your profitability.

 

Over the long term, this will set the next generation up for success and help appease other stakeholders that you’re taking the sale of the business to the next generation seriously—and pursuing maximum value. However, this takes time.

 

“Working with a consultant is a good idea when you have a long runway, so that the suggested improvements have time to take hold. With forced or sudden sales, the advice usually doesn’t move the needle,” said Gregg. 

 

As always, slow and steady progress often makes the most sense. That’s why transitioning your business to the next generation should be considered a long-term play.

A Few Gifting Strategies

When considering how you’ll gift your business, you want to do so in a tax-efficient manner. We review some possible options, though your situation is unique to you. Talk with your Wealth Advisor, estate planner, tax advisor and lawyer about what’s right for your business.

 

Annual gifting may be successful if you know far in advance what your intentions are and you have an LLC, S-corp, or another business structure that allows you to gift shares in the business. By making small annual gifts under the federal gift tax threshold, your successors can slowly gain a substantial ownership share in the business, while your overall gift tax burden is ultimately reduced.

 

Consider discounting the value of the gifts, so that you maximize the amount you can give before triggering a taxable event. Two common discounting strategies include initially giving a non-controlling interest (which is worth less), or discounting the value of the business because it’s small enough to suffer from a lack of marketability.

 

Over time, your children will ultimately gain a controlling share of your business—or the whole business—and you’ll be able to exit gracefully.

 

A federal gift tax exemption can allow you to make a larger one-time gift tax-free. When the federal estate tax threshold is large, this strategy may make particular sense. Even if the threshold later shrinks below your gift amount, the gift may be grandfathered in tax-free, though there are no guarantees. Talk with your tax advisor for more details.

 

An irrevocable trust is a gifting strategy typically used when your children are not yet ready to run or receive the business. Perhaps they are too young, for example, or they’re older, but have little interest in being hands-on managers. Once you put your business in an irrevocable trust, the decision cannot easily be changed.

 

As the grantor, you set the terms of the trust, but a designated trustee oversees your business—and the trust owns it. How it’s arranged is up to you: you could choose to have your business pass on to a successor, a set of successors, or even skip a generation. This could happen at your passing, at a specific year, or at another milestone of your choosing.

 

There are several advantages: it protects you from lawsuits and creditors, and your business is no longer part of the probate process. Additionally, it’s not part of your taxable estate, which may save the next generation a substantial amount on taxes.

 

However, you no longer control your business; it’s no longer your property. The trust will hire a management team to run the business and make profit distributions to your children, as specified by the rules of the trust. This means you should place a premium on carefully selecting a high-quality trustee.  

 

A Grantor Retained Annuity Trust (GRAT) is a type of irrevocable trust that’s meant to expire within two to three years. It’s most successful when you expect explosive growth in your business in a short time frame. It allows you to move that growth out of your estate and towards another individual or entity, in this case your children. 

 

It works like this: When you establish a GRAT, you appraise the value of the business. At the expiration of the GRAT, you keep that value, plus an additional percentage specified by the IRS, while the beneficiary (your children, in this case) receive the remainder of the value of the business, usually in the form of stock. So, for example, if your business grows four-fold in that timeframe, your children will receive substantial value, while you’ll retain your initial shares.

 

The possible downside is if you pass away before the expiration of the GRAT, your entire business is treated as part of your estate and your successors are again responsible for the estate tax liability. Another possible downside: if your business value doesn’t grow quickly or depreciates, there will be no value remaining for the beneficiary.

Lastly, Leverage Your Financial Team

You’ve worked years to grow your business. As you develop your plan to transition it to your kids, you want to have expertise in your corner. Work with your Wealth Advisor, accountant, estate planner, business consultant and lawyer—and make sure you have the right team in place. Then, get everyone in a room, so you can coordinate your plan and amplify ideas. You may be surprised by how many efficiencies can be found when several experts work together on your behalf.

 

At 1834, we believe in the value of holistic wealth management. As a business owner, especially, an integrated view of your personal and business finances can be invaluable during times of major transition. If that sounds like what you need, let’s talk—we’re happy to help.