Selling or transferring your company to your kids is a potential minefield for which careful planning and thoughtful anticipation are prerequisites.
If you own a business and have children, you may have already begun weighing your options regarding your company’s future ownership. Will you sell it to a third party, or do you want it to remain a family business?
For the purpose of this article, we will assume that:
- you want to keep your business in the family;
- you have multiple children; and
- at least one of them is a good candidate to succeed you in running the business.
If that describes your situation, read on. We will examine a number of important questions and challenges that, effectively addressed, can either provide a roadmap for your successful transition of ownership to the next generation, or show you a different destination altogether.
“Successfully transferring business ownership to your children takes more than a little thought and planning,” notes an America Express Kabbage article, Transferring Business Ownership to Your Kids. “Done right, it can ensure income, security and a chance to make a difference for the next generation. Done wrong, it can lose both the business and good relationships between your kids.”
Here are some fundamental components of planning for your intrafamily transition:
- Estimate the amount of assets or income you and your spouse need to secure your financial independence after you no longer own the company.
- Determine whether and how the company can generate enough revenue to support your needs and the needs of your successor(s).
- Pick an exit date – even a tentative target – for planning purposes.
- As soon as you see the need, consult with a professional advisor; the right attorney, accountant, or financial advisors can inject insight and objectivity into your planning process.
- Determine a realistic business value. If you are going to sell the business to your kids, offering a discount is fine – as long as you have a reliable and (for tax purposes) defendable starting value.
- When the time is right (sooner than later), include your kids in the discussion.
- Determine the best way to transfer the business to your kids (see a helpful Merrill article, “Smart Ways to Transfer the Family Business,” for potential options)
- Know which of your children should own your business and which should run your business.
Confronting those last considerations – ownership, management and, inevitably, money – is where many intra-family transfers come off of the rails, and it is on that issue that we will focus the remainder of this article.
Consider the example of Austin, whose trucking company, in a typical year, generates net income of about $3 million. Austin and his wife have three adult children: Kevin, a video game developer; Jennifer, a college professor; and Mike, who went to work for his dad right out of college, has performed well for 15 years at every level, and is Austin’s heir apparent.
Thoughts of slowing down and ultimately retiring caused Austin to begin planning for the company’s transition. With the best of intentions, he convened a family meeting and laid out his plan for transferring to his three kids the company that comprises the lion’s share of his substantial estate (and their inheritance).
Austin’s plan: The kids would form and own equal interests in an LLC, of which Mike would be the managing member. Austin would convey to the kids’ LLC his ownership in the trucking company, in exchange for a $7 million note that would be paid over 10 years in equal monthly payments. Annual profits would be divided equally among the three kids. Mike would run the company.
The kids’ response: At first, crickets. Then …
- Mike: How much am I going to be paid?
- Kevin: How do we know that $7 million is a fair price?
- Jennifer: What if the company can’t make the payments? Are you going to foreclose on us?
- Mike: I’ve worked hard for the company for 15 years. Doesn’t sweat equity entitle me to more than a third ownership?
- Kevin: Mike’s going to want the company to keep as much of the profits as possible. How are we going to get our share?
- Mike: Do I have to take orders from Kevin and Jennifer?
- Jennifer: This is our inheritance. When are we going to get our money? Can I find a buyer for my share of the company? What’s my share going to be worth?
… and so on.
A Forbes article, “Business Transition Planning: How To Leave Your Company To Your Children,” poses a number of questions intended to head off unintended consequences such as those encountered by Austin, including:
- To which kids and in what percentages do I want to transfer my interests?
- How much of the business do I want to transfer now?
- Do I transfer it to all of my kids, or just to the ones who are actively working in the business?
- If not all of the kids are to receive a share, are the non-participating children somehow “made whole” with some other gifts or arrangements?
- If the parent wants to benefit all children but not all are involved in the business, should some distinction between voting and non-voting shares be considered, or some different classes of shares?
- If ownership is going to be vested equally among the children, how will the involved child be compensated (through income and appreciation) to keep him or her motivated to run the business?
How do you handle multiple children’s money needs and expectations? The business may be profitable enough to support your family, but can it also support the families of all of your kids? How do you fairly distribute profits while taking care of the child who is running the company and actually generating those profits?
If the makeup of your estate allows such flexibility, the best plan may be to transfer the business only to the child who takes over leadership, and equitably leave non-business assets to the other children.
Whatever your approach, the complexities noted in this article should at least help you recognize the challenges for which you need to be prepared. It should also help you discern whether keeping the business in the family is truly a viable option, or selling it to a third party is the more realistic course.