Although family businesses often do not survive for multiple generations, many business owners seek to grow the business and ultimately keep it within the family. Accordingly, effective business succession planning can be critical for the long-term success of a family business. Some key points to consider when planning for business succession are listed below.
Control The business owner must determine the appropriate time frame for transitioning control of the family business to the next generation. This is often a difficult and emotional decision because the owner likely spent a lifetime building the business and views it as representative of his or her “life’s work.” A business succession plan may include an initial transfer of a minority interest or non-voting interest to the next generation as a first step, allowing the owner to maintain control while beginning the process of transferring economic value over time. After an initial transfer of noncontrolling interests, the owner may begin transferring controlling interests. It is imperative that the first transfer of a controlling interest take place at a time when the owner is fully ready to cede control (as opposed to transferring control solely for tax planning purposes), since family tensions can arise if the senior generation is not in fact ready to transfer control to the next generation. The owner should keep in mind that the structure of the family business (i.e., limited liability company, limited partnership, corporation) may affect the manner in which transfer of control may be achieved and should be considered when creating the succession plan.
Future Leadership Choosing a successor is a critical component of a business succession plan. If one family member has been involved in the day-to-day operations of the business and has taken an active role in growing the business, he or she may be the obvious choice. However, when several family members have been involved in the business over a period of time, the decision of who shall take the reins becomes more difficult. Ultimately, regardless of the ultimate choice of successor, the process for selecting the managers of the business should be addressed in the business organizational documents and adhered to going forward.
Issues Involving Non-Active Family Members The owner should consider whether or not to benefit all family members equally when transferring business interests and in what manner to involve or benefit family members who have not been active participants. For example, the owner may choose to transfer family business interests to a child who is involved in the business and other assets of equal value to a child who is not involved in the business. While equalization of transfers is possible, it requires careful and consistent valuation of the business interests and other assets, and various tax and legal implications must be considered when attempting to achieve equal treatment of participating and non-participating children. Life insurance can play a key role in equalization.
Continuing Compensation for Retiring Generation When transferring ownership and management, the owner may want to provide for his or her future income. Continuing compensation for the retiring generation should be addressed in the business succession plan, if necessary, to meet the owner’s cash flow needs going forward. Income taxation of continuing compensation should be carefully considered when structuring the business succession plan since receipts characterized as salary and receipts characterized as distributions from the business will be treated differently for income tax purposes. Business owners should discuss these issues with tax advisors prior to creating and implementing a business succession plan.
Conclusion The key to successful business succession is careful planning and communication between the owner and his or her intended successors. Decisions should not be solely motivated by income and transfer tax implications; long-term family goals and values also must be taken into account. Christian Searcy