Owning and running a family business, especially one that is multi-generational, has its rewards and challenges. A great deal of satisfaction can be derived from keeping the business in the family and providing a lasting legacy for the founders. However, family dynamics may present challenges and concerns not present in other business ownership structures. Unfortunately, statistics show the chance of a family business successfully transitioning from the first generation to the second is not very favorable, and the odds become even less probable for a transfer to a subsequent generation. If you are considering passing the torch to the next generation, you are probably realizing it is not easy. How do you determine if transitioning your family business to the next generation is the right thing to do?
If you are like most business owners, you will need to unlock some of the wealth trapped inside your business in order to afford the next phase of your life. Unlike a third-party sale, which usually provides some immediate liquidity up front, a family sale may be structured quite differently. Here are some things to consider.
- How do you get the money out of the business—third-party financing, seller financing, earn-out?
- Can the business afford to take on debt?
- How would debt repayment affect cash flows?
- How do you objectively determine and agree on a value for the business?
- How much will the taxes be that are generated by the transition? How will those be paid?
- What can you do to ensure you receive payment if you are no longer involved in the business?
- Can you afford to gift shares to a family member?
Fortunately, there are methods of transfer that can provide tax efficiency and even your maintaining control. Often, with proper planning and ample time, taxes can be dramatically reduced. However, depending on the method, your business value may be determined more by IRS rules than by you. Their guidelines require certain methodologies be applied in determining the value of a privately held business seeking an internal transfer. These rules can substantially reduce the value of your business, which, on one hand, can save taxes but, on the other, may not provide you with needed funds for your future.
Does the next generation possess the skills and abilities required to take over the business? This may seem like a crazy question, but too many businesses are transferred to the next generation merely as a birthright. The fact is only a small percentage of businesses survive into the second generation. You need to think about some of the following:
- Have they been adequately mentored and trained for their new role?
- Do they really aspire to take over the business or just want the title?
- Can they grow the business to the next level?
This is where objectivity and brutal honesty really matter. Many times, the family owners assume the member who is next in line should take over the business. Is this what that person really wants? Is he or she capable? Just because the person is a family member does not mean the individual is the best choice for the leadership of the company. He or she may still economically benefit or be involved in the business, but the role with the company should be aligned to match the person’s skills, goals, abilities, and what is best for the company.
Most owners consider keeping family harmony of utmost importance. You want to be able to enjoy the holidays together and function as a family, regardless of what is occurring with the business. Unexpected tension and discord can occur when a family member in the business becomes the new owner through sale or gift. Here are just a few examples of things to consider.
- Do you have other immediate family members who are not active in the business?
- Do those family members derive any economic benefit from the business?
- Have you made provisions in your estate planning for other heirs to be adequately compensated without splitting up the company?
Often owners assume the rest of the family is fine with the owner’s chosen family member in the business taking over the ownership. Most often this has not been openly discussed. Many owners believe that their other children have their own lives and careers and have no interest in the business. The family may, however, still view this sale or transfer as an economic event and hold resentment towards the sibling taking over. The worst cases involve an owner leaving the business equally to several family members, not all of whom are actively involved in the business, in an attempt to be fair. There is no quicker way to destroy a business than have children in the business and those not in the business as co-owners.
As you can see this is a complex topic and needs to be carefully considered. The guidance and assistance of a trained transition planner is invaluable in these situations. He or she can provide the objectivity and skills necessary to assist you in determining if you should keep the family business in the family and, if so, how it should be accomplished. Your family harmony, legacy, and financial future depend on making sound business decisions in a well-thought-out way.
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