Passing down a family business is a time-honored tradition in American enterprise.
According to the Cornell University Smith Family Business Initiative, approximately 75% of small businesses rely on family members to run and maintain a business. These businesses are responsible for over half of US jobs and over two-thirds of new job positions.
However, transferring ownership and control of a business can be daunting, all the more reason business owners should plan in advance to ensure a smooth and successful handoff.
Here are some useful tips on preventing that headache.
Preparation
Selecting a successor is the first step in planning for a successful transition. This decision is often difficult, especially if multiple family members are interested in running the business.
The chosen candidate should have the necessary skills, experience, and passion to run the business effectively. As this article from the Harvard Business Review points out, family members are not always interested or even the best candidates for succession.
It is essential to have open and honest communication with all family members and consider non-family candidates if necessary. Avoid creating a position solely to accommodate family members if they lack the qualifications or the motivation to succeed.
The Business Succession Plan
Once a successor(s) has been identified, creating a detailed Business Succession Plan is important. The plan should include/address the following:
- Hold a meeting to discuss the direction and ownership of the business. This is a chance for the owner to set a clear path for their intentions and minimize potential conflicts among family members to ensure a smooth transition.
- Plan for multiple succession possibilities, such as owner death, traditional succession, forced liquidity, or bankruptcy scenarios.
- Maintain accurate financial records and ensure that projections account for the necessary cash flow to finance the retiring owner(s) if necessary.
- Designate the allotment and type of any shares in the business.
Tax Implications
Transferring business ownership can also have significant tax implications, including a Gift Tax, an Estate Tax (if the donor passes away before the sale is complete), and a Capital Gains Tax. Owners should consult with a financial planner to ensure they create the best strategy when it comes to taxes.
A Capital Gains Tax Exemption is available in some circumstances, but it might be harder to qualify for when the business is sold to another family member. Setting up a trust or an estate freeze is often a viable option to reduce tax consequences.
Owners may also attempt to sell part of the business and only pay capital gains taxes on the profits from said partial sale. This allows the owner to retain partial ownership and continue drawing a profit in retirement.
Letting Go of the Reigns
Transferring ownership of a family business is a significant milestone, and owners must be prepared to let go of their control and entrust the business to their successors.
Many owners view their business as their pride and joy and find it difficult to give up control. Many businesses create different classes of shares, which can define the amount of influence various members of the owner group will have. Again, the better the planning and communication among family members, the better the chances of a successful transfer.
70% of second-generation businesses fail due to improper succession planning, but a little effort can ensure that a business survives well into the future.