Publications
Succession Planning for the Family Business: Part 1
One of the most gratifying aspects of owning a family business is to
leave a legacy to the next generation. Unfortunately, without planning,
the legacy can turn into a liability. Part I of this article will review
some of the things to think about when planning for business succession.
Part II (in the next Advisory) will address the tax issues of
transferring your business.
Gift versus Sale versus Compensation
One of the simplest ways to transfer your business to the next generation
is to give it away. The advantage of making gifts of the business, is that any
future appreciation in your company’s value will be out of your estate when you
die. If the child’s compensation does not reflect what the child could
earn outside the family business and therefore the child is, in effect,
paying for any stock that is gifted, you can recognize this by making a
gift to your child to “compensate” for lost wages.
die. If the child’s compensation does not reflect what the child could
earn outside the family business and therefore the child is, in effect,
paying for any stock that is gifted, you can recognize this by making a
gift to your child to “compensate” for lost wages.
Instead of making a gift, consider whether a child should be asked to
make a financial contribution for the interest in the company, formally
or informally. There may be financial benefits for you and psychological
benefits for your child in purchasing a portion of the stock. A purchase
would help ensure a cash flow to the sellers that would enhance their
long-term financial security. Structured properly, there would also be
estate taxes savings. Finally, children who have made a personal
financial commitment to their acquisition of the business sometimes have
a greater commitment to the business.
make a financial contribution for the interest in the company, formally
or informally. There may be financial benefits for you and psychological
benefits for your child in purchasing a portion of the stock. A purchase
would help ensure a cash flow to the sellers that would enhance their
long-term financial security. Structured properly, there would also be
estate taxes savings. Finally, children who have made a personal
financial commitment to their acquisition of the business sometimes have
a greater commitment to the business.
Equalizing shares of nonparticipant children
Perhaps one of the most difficult issues in business succession planning
is providing for children who are not involved in the family business. If your
estate is big enough, this might just be a matter of leaving the business
to the children who are participating and other assets to your other children.
When thinking about an equalization approach, consider to what extent is
the future appreciation in the value of the business attributable to
your children’s efforts and how might they benefit from the increase in
value without, in effect, sharing this appreciation with the
nonparticipant children. One way is to make lifetime gifts of the
business now as a means of rewarding the participating child over and
above compensation. Any equalizing in your estate planning documents
would then only apply to the business interest that you retain at your
death.
the future appreciation in the value of the business attributable to
your children’s efforts and how might they benefit from the increase in
value without, in effect, sharing this appreciation with the
nonparticipant children. One way is to make lifetime gifts of the
business now as a means of rewarding the participating child over and
above compensation. Any equalizing in your estate planning documents
would then only apply to the business interest that you retain at your
death.
Life insurance can also play a valuable role in equalizing the shares of
your children, especially if your business comprises a large part of
your net worth. For example, you might purchase joint and survivor life
insurance on the life of you and your spouse (which is generally less
expensive than insurance on one person’s life), which will be paid to
the nonparticipant children. To keep the insurance proceeds out of your
estate, the insurance should be owned by an insurance trust. If you are
still active in the business, life insurance can also be used to provide
the participating child with cash with which to buy out your interest.
your children, especially if your business comprises a large part of
your net worth. For example, you might purchase joint and survivor life
insurance on the life of you and your spouse (which is generally less
expensive than insurance on one person’s life), which will be paid to
the nonparticipant children. To keep the insurance proceeds out of your
estate, the insurance should be owned by an insurance trust. If you are
still active in the business, life insurance can also be used to provide
the participating child with cash with which to buy out your interest.
Post Gift Planning
Once a business interest has been given away, it is
imperative that you enter into a shareholders’ agreement which will
formalize the implications in the event of a shareholder’s death,
disability or retirement. If a child should die, become disabled, or
leave the company, you could be granted the option to buy back shares.
If your company is operated in a partnership or limited liability
company structure, comparable provisions should be added to your
partnership or operating agreement.
imperative that you enter into a shareholders’ agreement which will
formalize the implications in the event of a shareholder’s death,
disability or retirement. If a child should die, become disabled, or
leave the company, you could be granted the option to buy back shares.
If your company is operated in a partnership or limited liability
company structure, comparable provisions should be added to your
partnership or operating agreement.