Most businesses in America are small businesses. A large portion of those small business are classified as family business.
Family businesses can range from those run by siblings, cousins or other relatives and those that may have a multi-generational situation. A common goal is to keep the business in the family. The odds are against you for getting to the second generation, and even less as you go deeper into the family tree. Advance planning of a transition can save a lot of heartache, money and taxes.
Break your planning into two distinct parts: ownership and employment. Neither should guarantee the other, and even with family, you need to approach each of these two matters at an arm’s length.
Ownership is something that many families want divided equally amongst their children. Sometimes this works and other times it doesn’t. Larger businesses with a good infrastructure, cash flow and significant value have a better chance of getting ownership into the hands of non-employee owners.
These larger firms are more likely to have systems and processes in place from accounting and CEO down to sales and service leaders. A well-run large business typically has a succession plan where the loss of an owner may be less detrimental to the ongoing operation of that business.
For smaller business, having owners that don’t work in the business could cause a problem. If you have several children, you may find it helpful to leave the business to those who are a part of the business today and equalize any inheritance or gifts to your other children with other assets. If you don’t have any other assets, consider life insurance or a plan whereby they all inherit the business equally with an immediate obligation to buy out those not working in the business with whatever terms are necessary to complete the transaction.
In any case, you would need to start the ownership succession with a valuation of the business. This matters for gift and estate purposes and must be done correctly. Ownership transition can be a blend of lifetime gifts, sales and bequests at death. There are advantages to starting this sooner than later for businesses with substantial value. With today’s low interest rates, a sale with a long-term payment schedule may also make sense. The IRS prescribes the minimum rate you must charge a family member.
The employment side is a bit easier. Simply tackle that as you have any other employment situation. Take ownership off the table and hire family/owners as you would anyone else. Their continued employment and future growth within the organization shouldn’t be taken for granted and earned according to a development plan prescribed by the current leaders of the company. Without a merit-based system, you’ll find it tough to attract and retain good talent beyond the family ranks.
Executing a plan like this can take years, with small steps taken each year you can easily track your progress where even a little is better than none.
John P. Napolitano CFP®, CPA is CEO of Napier Financial in Braintree, MA. Visit John P Napolitano on LinkedIn or napierfinancial.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investment advice offered through US Financial Advisors, a Registered Investment Advisor. US Financial Advisors and US Wealth Management are separate entities from LPL Financial. He can be reached at 781-849-9200.
