Splitting up a family business is hardly a simple process.
Many families fail to successfully pass their business on to the next generation due to failure to plan for the transition. This is especially tricky when some children work within the business while others do not.
However, building a detailed succession and estate plan for the family business is essential, and families which fail to do so may risk not only family harmony, but also their most valuable asset – their business.
How can a family pass on the business – and access to the assets necessary to run it – to an heir without neglecting the family members who are not involved in the business? Fortunately, with careful and thoughtful planning, there are several ways to achieve the desired outcome.
Here are three of the most common options:
Purchase at Retirement – The heir to the family business can purchase the business from his/her parents once they have reached retirement age, and the proceeds can then be incorporated into the parents’ estate plan and divided among the heirs accordingly. The advantage of this scenario is that the parents can see how each child’s involvement in the business progresses, and then sell to the children who truly have an interest in the business. However, the downside is that the child or children will need the cash-flow to make the purchase and the parents will need to treat the sale as capital gains.
Purchase at Death – Alternatively, the heir to the business can purchase the business after the parents’ death through the estate. This way, the parents can take advantage of estate tax rules to eliminate the capital gains tax; however, the cost of the purchase may increase due to the value increasing over time. If the value of the sale is included in the estate value, then the estate can be divided as determined by the parents.
Equalize with Life Insurance – One way to equalize the distribution of the estate among the children is by utilizing life insurance. The child purchasing the business, either during life or as part of the estate, can purchase a policy on the life of the mom and/or dad. The policy’s death benefit can then be used to pay the remainder of the purchase price of the predetermined sale. An alternate method would be for the business to be gifted to the child working in the business while the mom and dad name the other children as beneficiaries of their life insurance policy, thus equalizing the distributions to the heirs.
The final key to transferring the family business to the next generation is to have a detailed plan in place. Without a detailed plan for how the family business should continue, even the best company may not survive the many risks and obstacles that companies face over time.