If you are considering any kind of personal estate planning for your immediate or long-term needs, you are likely considering standard but practical estate planning tools like:
- Last will and testament
- Revocable living trust
- Durable power of attorney
- Life insurance and other payable-on-death beneficiary designations
All of these are useful instruments that can accomplish many of your common estate planning goals.
However, if you own a family business that is part of your estate plan, there are several important issues that you must consider before simply including your family business in the common estate planning instruments that satisfy your personal estate planning needs.
Owning or managing a closely held family business can be rewarding, but it can be difficult. In addition to the normal demands of growing a successful business, your decisions and responsibilities as an owner or manager of a closely held business are replete with all of the emotional stresses that accompany normal family relationships. Managing a combination of business strategy and family dynamics can be a delicate balancing act.
Perhaps the most precarious decision you have to make and the one that may have the greatest impact on the long-term viability of your family business is the issue of the succession of your business to future generations. This could occur for many reasons, including:
Experts estimate that 85% of the conflict in family businesses that are in crisis are related to the issue of succession. The best way to prevent these conflicts is to resolve the issues relevant to the succession of your family business now, before the conflicts arise.
Although business succession planning can play a significant role in the viability of your business, many family business owners do not take the steps necessary to ensure a smooth transition to their successors.
In a study of 1,000 family businesses conducted by the American Family Business Survey, researchers found that approximately 40% of family business owners anticipated retiring within 10 years. Of those, researchers concluded that the further away from retirement a family business owner was, the less likely the owner was to have selected a successor for the business. (See Table 1)
|Family Business Owners' Anticipated Retirement and Planned Succession|
|Years Expected Until Retirement||Selected a Successor|
|No Retirement Planned||0%|
Researchers concluded that this "is not beneficial to the family, the firm, its employees and its clients."
In conjunction with another study estimating the percentage of family businesses that successfully transition to another generation (see Table 2), this research suggests that a lack of succession planning may affect the future viability of your family business.
|1st Generation Family Business Succeeded to Another Generation|
|Succeeding Generation||Business Succeeded|
This data also suggests that family business owners tend to avoid making succession decisions until it is necessary or too late to salvage the business.
In another study of 387 closely held businesses, for which only 50% of the businesses had a succession plan, family business owners offered common reasons for such failing:
- 31.4% felt uncomfortable making the necessary decisions
- 14.4% thought the decision was too difficult to deal with
Although the decision to transition your family business to another generation can be difficult and complex, there are numerous estate planning tools and techniques that can help you to make those difficult decisions. With proper planning, you can have the confidence that you have made prudent decisions for your business and your family, and the peace of mind of knowing that your business is likely to continue thriving under the ownership and management of future generations.
Here are some simple but important steps you can take to effectively plan for the succession of your family business.
As Tables 1 and 2 suggest, even if you have no immediate plans to retire, the longer you delay in planning for the possible succession of your family business, the less likely your business will transition to future generations. Consider that even if you never plan to retire from your business, it is still important to have a succession plan in place.
- Unanticipated retirement
- Disability or incapacity
Because you are successfully operating your business, you likely do not leave important business decisions to chance. And although currently you may not plan to retire, circumstances could change. You may decide later that retirement is the best option for you and for the business. Do not leave the succession of your business to chance.
At any time, you risk the possibility of sudden disability or incapacity that could prevent you from effectively managing the day-to-day operations of your business. When confronting such unexpected circumstances, if your business is to continue without interruption, you need a succession plan already in place that is the product of your own thoughtful consideration. Being forced to make hasty decisions about future operations or being unable to make decisions at all could be devastating to the future of your family business and to your employees.
Whether you plan to retire or risk unexpected retirement, disability or incapacity, you must plan ahead and select your successor now, if your family business is to survive in the future.
- You need time to make sure your chosen successor is willing to assume your role
- You need time to train your chosen successor in his or her new role
- You need time to determine if your chosen successor will be competent in his or her new role
- You need time to allow other family members, who may be resentful or disappointed in your selection, to see the propriety of your decision
- You need time to allow your employees to adapt to your chosen successor's management style and performance
Although you should not delay in developing your succession plan, you also should not make hasty emotional decisions. A 2007 study by PricewaterhouseCoopers estimates that almost two-thirds of family businesses transition to family members without any assessment of the family members' qualifications. Selecting a child or other relative who is involved in the business as your successor may seem natural, but when making this important business decision, you must be objective and honest about whether this is the best decision for the company. In assessing this, you should ask yourself the following questions:
- Do I feel pressured or compelled to select my child?
- Does my child expect or assume that I will select him or her?
- Have I carefully considered candidates other than my child?
- Do I feel confident about my decision?
- Have I obtained and considered the opinions of other professionals who are informed about my business, such as my attorney or accountant?
- Am I making this decision because it benefits my child more than it benefits the business?
- Is my decision likely to create tension, animosity, or resentment among my other children or relatives?
Your honest answers to these questions may indicate that you may need to reconsider your selection of your successor.
Even if you are convinced that your selection for a successor to your family business is a sound one, you should obtain and consider the advice of those professionals who are most closely associated and familiar with the inner workings of your company. These may include your:
- Estate planning advisor
- Insurance agent
If opinions differ, you should consider why. Ultimately, a decision must be made, and the decision must be yours. Be sure that your decision is:
- Not hasty
- Based on buisness considerations, not emotions
One of the primary reasons businesses fail to successfully transition to the next generation is failure to understand and employ effective business and personal tax planning. Important tax considerations include:
- Income taxes
- Estate taxes
- Transfer taxes
- Generation-skipping taxes
The American Family Business Survey study estimates that in 2002, 68% of family business owners had a good understanding of their estate taxes. By 2007, this number had decreased by nearly 25%. Understanding and minimizing the tax consequences upon the transition of your business to the next generation can determine the viability of your business in the future or even whether your business can continue at all.
Whereas every year business becomes more complex and taxes become more complicated, it is imperative to employ a tax advisor who can anticipate the tax consequences of your business succession and implement the most effective estate planning tools to minimize these consequences.
Another significant reason why family businesses fail to succeed to another generation is that owners fail to broaden their use of effective estate planning resources. It is estimated that for more than a third of family business owners (31.4%) a last will and testament is the sole estate planning resource. The failure to take advantage of more effective estate planning and tax-saving instruments can negatively affect the viability of your company in the future.
Here are some effective estate planning tools that you may consider with your attorney when planning your business succession:
- Trusts. The effective use of various types of trusts, for owners as well as next-generation beneficiaries, is an effective way to minimize taxes and reconcile many of the succession difficulties discussed here. How benefits of the trust are administered can affect tax savings, so any decisions to incorporate trusts should be done in consultation with your estate planning attorney.
One trust technique commonly used to solve the problem of inexperienced or uninspired family successors is to appoint co-trustees of the trust to share fiduciary responsibilities. Because a family business integrates the difficulties of both the business and the family, you might appoint a corporate trustee to be responsible for the business aspects of the company (CEO, etc.) and your selected family member to handle the human relations aspects of the company (HR, etc).
If you select only family members to succeed you and to serve as co-trustees, it may be prudent to appoint an odd number of co-trustees, so as to avoid conflict. If not prudent or possible, you might consider appointing what is called a "trust protector." The trust protector functions to resolve conflict between co-trustees and may be subject to different fiduciary duties, which you may designate.
- Family limited liability company (FLLC). A family limited liability company (FLLC) is a business structure that includes only family members and is another effective resources for succeeding your business to your child through trust. This is accomplished by allocating voting and non-voting interests in the business. As the participating owner, you would retain a 1% voting interest in your company and your child would retain a 99% non-voting interest, through trust. You would control the FLLC as the sole voting interest, while receiving the benefit of the discounted value of the 99% non-voting interest, as well as the added tax savings.
- Corporate structure. Many of the same succession concerns can be addressed without the use of a generational trust through the corporate structure with which you operate your business. One benefit of a corporate partnership over a sole proprietorship is that it separates your business assets from the personal assets comprising your taxable estate. Also, the business is able to continue to operate after your personal estate has been probated.
Within the corporate structure, boards and committees with designated corporate and fiduciary functions can be structured to accommodate any possible conflicts or incompetence created by the selection of family members as succeeding owners. The advantages and disadvantages of structuring co-trusteeships, corporate boards and advisory committees that include family members should be discussed with your estate planning attorney before creating any of these structures.
- Completed gifts. Gifting assets is always an effective way to reduce estate taxes and take advantages of allowable exemptions. To the extent that you can incorporate lifetime gifts into your comprehensive estate plan, you should begin to provide completed gifts to the next generation if reducing your taxable estate is necessary. Your estate planning or tax attorney can advise you on the most effective way to use this estate planning technique.
- Security interests. To afford family members a financial interest in the business without handing over control of the day-to-day operations, securities or stock interests, when available, can be an effective way to appease emotions and gain tax advantages at the same time. If family members want to participate more in the daily operations, specific stock options can also afford voting rights.
- Buy-sell agreements. A buy-sell agreement is simply a contract between respective co-owners of your business that identifies and redistributes ownership interests when someone exits the company or places business interests at risk. These are more commonly known as "buy-out" agreements. Although buy-sell agreements may have less tax-saving impact than other estate planning tools, they are an effective contractual tool for predicting and maintaining control of business operations, especially during transitional succession periods, while still ensuring the financial security of family members who choose to retire or otherwise leave the business.
Buy-sell agreements may address issues related to a variety of events that put business interests at risk, such as:
Your corporate or estate planning attorney can advise you on the most effective provisions to include in a buy-sell agreement and how to maximize the benefits derived from them.
- Life insurance. Your family business should hold life insurance on its owners to ensure that the business can buy out a decedent owner’s interests in the company and provide for affected family members.
- Self-canceling installment note (SCIN). Another tax-saving option that transfers existing business interests from a current owner to the next generation (such as when a child obtains an interest in the family business by purchasing the interest of the participating owner) is a self-canceling installment note or (SCIN). A SCIN is a promissory note that allows a child to purchase interest in the company with installment payments. If the owner selling his or her interest dies, any outstanding payments are canceled. However the purchasing family member may pay a higher interest rate to benefit from the ability to cancel payments upon the death of the participating owner. The purchaser must pay a premium for this cancelation feature in the form of either a higher interest rate or a larger purchase price.
The disadvantage of using a SCIN is that it is difficult to value, but it can be an effective way to plan for business succession and minimize estate and gift taxes at the same time.
Whether your estate planning consists of basic property distribution instruments like a last will and testament or simple trust, or a patchwork of other estate planning tools and techniques, there are a variety of resources to consider and discuss with your estate planning attorney. Together, you will determine which resources are most effective for you to accomplish your immediate and long-term estate planning goals.
As you consider the goal of the succession of your family business to the next generation and beyond, the resources that will be most effective for you may depend on a host of relevant factors, which may be different for every business, business owner, and family. Some of these may include:
- Whether you have a significant taxable estate
- Your age, health, continued capacity and life expectancy
- Whether you wish to continue to participate in the operation of your business until a successor takes control
- Whether you plan to retire
- Whether you require income for retirement
- Whether you have children or other family members who will be affected by your selection of a successor
Your estate planning attorney can help you determine how these factors will affect your decision to select an appropriate successor to you family business. And the best time to do that planning is now.