The vast majority of businesses are closely held small businesses. Unfortunately, less than one-third of these businesses will survive from the first to the second generation. While there are many reasons, three of the more common include family conflicts, hefty taxation and failure to plan for succession.
Family conflicts can arise for a number of reasons sibling rivalry, a desire for greater authority and decision-making opportunities than the senior generation may deem appropriate, or the younger generation viewing the senior generation as a hindrance to progress.
Hefty transfer taxes, including capital gains taxes or ordinary income taxes may occur when selling the business to children or outsiders. Gift taxes are due if gifting of assets/stock is the chosen transfer method. Estate taxes arise as the IRS can collect 40 percent of the deceased family’s net worth over $5,490,000. Most business owners are illiquid and taxation requirements may result in the forced sale of the business.
Planning for Succession
In planning, the first step in exiting a business involves evaluating your own financial security. You may not have enough resources “independent” of the business to allow you to yield voting control. If you do not have sufficient resources, then a plan that allows you to maintain control and income would be a safer alternative. Many times if a business is sold, the selling shareholder is asked to hold the promissory note, with very little cash to be paid up front. This poses a high risk to a retirement that is heavily dependent on the successors or their family members’ abilities to navigate during uncertain economic times.
The next step is to groom and identify a successor. Some family members may not have all the attributes of a leader and may require coaching, training or even assistance from the management team to “fill the shoes.” It is important that the management team is offered a bonus or incentive program that rewards them for their continued service and tutoring of younger family members. Since key people often leave a firm when a change in ownership takes place, a “golden handcuff” program could help prevent this.
Finally, determine the when and how of transferring the business. The when involves questions of how quickly authority is shared and whether it is a gradual process — preferred — or a much quicker transition, possibly due to an illness to the senior generation.
How you transfer the business can be done many ways, but the four basic ways include (1) sell the business during your lifetime to family, key people or an outside third party; (2) sell the business at your death through a buy-sell agreement between the seller and future buyers; (3) gift the business at death through a bequest in your Will, preferably to “active” children, rather than equally amongst all, or (4) gift the business away during life.
Business owners are often so busy with the day-to-day that they rarely sit back and determine their long-term succession and retirement issues. If you would like to know what your best choices are and strategies appropriate to your situation, please contact Donald Hannahs, CFP®.
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To contact Don for further discussion you may email him at: firstname.lastname@example.org or call 757-271-8824. Don is a Founding Partner of Planning Solutions Group, LLC. Starting his practice in 1987, Don has focused primarily on closely held business owner planning.