It's hard to relax when your legacy is in someone else's hands. This is the conflict that every entrepreneur faces when handing off the family business to the next generation. This scenario creates lots of mixed emotions. On one hand, you're thrilled by the idea of finally taking time to enjoy the fruits of your labor as you invest in travel, hobbies, and relaxation. On the other hand, you know the amount of blood, sweat, and tears it took to get your business to this level. You also understand how easily one wrong move could get it all unraveling. With the right plan, transitioning a family business to the next generation doesn't have to feel so risky. Here are some tips for doing it right.
Succession Planning
Detailed succession planning can eliminate close to 90% of the problems that pop up during the torch-passing process with family businesses. Succession planning is important because it ensures a smooth transition. It also squelches suspicions and competitions that can erode family operations. While there may be a temptation to avoid playing favorites or hurting someone's feelings, this is a part of the process that needs to be "strictly business" instead of personal. Fill leadership roles based on qualifications and skills. Additionally, roles within the organization need to be clearly defined to ensure that all parties understand their roles and responsibilities. They must also understand their limitations in terms of decision-making power. Don't pass the problem of poorly defined roles onto the next leader!
Communication and Training
For many people who grew up watching their parents or grandparents run a business, the family business is truly in their blood. However, you can't assume that proximity amounts to competency when handing a business over to family members. Extensive training will still be needed to prepare the next generation for leadership roles. If incoming leaders don't have training in business management or industry-specific skills, consider asking them to enroll in courses or complete certifications as part of the transition plan.
Open communication is also important. As the current steward of the business, your job is to communicate the vision and standards that you have for the business once it leaves your hands. This could take the form of delivering some hard truths about who you feel is actually competent enough to have a leadership role. In order to avoid sowing seeds of distrust, it's better to be blunt about your intentions than to let gossip and hurt feelings creep erode the business.
Legal and Financial Preparation
Transitioning a family business to the next generation isn't something that can be settled with a handshake. This isn't a case of proving how much you trust your family by operating on verbal or implied agreements. Ultimately, you need to take precise legal and financial steps to secure the future of the business. Everyone is protected when the right legal and financial preparations have been put into place. What does that look like when passing down a family business?
What kinds of things does a business owner need to think about when legacy planning for a profitable business? This requires a two-part strategy that protects both the business and the family members who may find themselves in a position to suddenly be in possession of assets or net worth that they've never handled before. Of course, you must also protect your own financial stability once regular income from a business stops coming in.
The first step here is looking at the value of the business. If you're like most business owners, a portion of your net worth is tied up in your company. That's why you'll most likely be in the position of needing to sell the business to your kids or heirs. Your plan for sale should take into account:
- The fair market value of the business.
- How much you'll need to support your lifestyle through retirement based on your age.
- The benefit of earning income from the sale versus the tax benefits of pursuing other options.
There are many ways to legally minimize succession taxes for family businesses that actually make a transition within the family advantageous over selling a business for a higher profit. One common strategy is to use gifting. If you own a small business, you can utilize the annual gift tax exclusion ($18,000 for single/$36,000 per married couple). While this tax exclusion can't be used to gift an entire business, it can be helpful for gifting interest in your business to heirs.
Another common strategy is to create a parallel business in the name of your children or heirs. This puts you in the position of handing over a startup instead of forfeiting your established and profitable business. This is an option to consider if you're not ready to fully step away even though you want to begin the legacy-building process. How does this look in real-world terms? Let's say that you own a winery. While you're ready to pivot from being in charge of operations, you aren't confident it's time to step down. You start a new business that sells hard seltzers that you name after your oldest son. Once the new business has been nurtured enough to have long-term value, you hand ownership over to him.
Finally, the intentionally defective grantor trust (IDGT) is another tax benefit that many business owners utilize as part of a transition strategy. The simplified explanation of IDGT is that it utilizes estate tax exemptions to avoid taxes when you transfer a business using a trust. It also plucks future appreciation from your estate in order to give that value to your heirs. Along with these benefits, IDGT waives transfer taxes as long as the business stays within the trust you've created. This is one of the strongest tools for long-term multigenerational estate planning.
Balancing Family Dynamics
Do you anticipate conflict when you announce your plan for succession? In some cases, this is unavoidable. However, one way to potentially tame tensions is to methodically outline your choices for succession in your succession plan based on logical reasoning. For example, highlighting a chosen successor's educational background, experience, and positioning within the family as strength points that influenced your decision instead of simply allowing decisions to seem either arbitrary or based on favoritism can get others in alignment. If multiple family members will be involved in operating the business, consider establishing a family council or board. This gives every sibling or family member a chance to have a decision-making role in the company regardless of their title.
Use Professional Guidance to Avoid Blind Spots in Succession Planning for Your Family Business
While you may have thought that building your family business was the hardest thing you'd ever do, many successful business owners are surprised to discover that navigating the emotions and dynamics of succession planning is actually tougher. Additionally, being good at building a business that you're an expert in is a completely different animal from succession planning and taxation optimization. Being good at your business doesn't necessarily equip you to navigate the financial and tax aspects of passing the torch. That's why seeking professional guidance to navigate the complexities of transitioning a family business can be essential for protecting your legacy.
There is a lot at stake financially and emotionally. Consider using ACRES to get hands-on guidance for transitioning your family business to the next generation.
Sources:
https://www.investopedia.com/terms/i/igdt.asp
https://www.usbank.com/wealth-management/financial-perspectives/financial-planning/business-owners/business-succession-planning-keeping-it-in-the-family.html
https://www.forbes.com/sites/catherineschnaubelt/2018/08/17/transitioning-your-family-business-to-the-next-generation/
