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5 Benefits and Challenges of Transferring a Business to Family

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5 Benefits and Challenges of Transferring a Business to Family

There are thousands of advisors, hundreds of books, and dozens of family-business centers dedicated to assuring the success of family-run businesses. In this post, we will present five benefits and five challenges for owners who are brave enough to transfer their businesses to the next generation and show how you, as an Exit Planning Advisor, can help implement the plan needed to achieve your client’s Exit Objectives.

Benefits of a Transfer to Family

1. Financial Security: As Exit Planning Advisors, we can help our clients receive the amount of income they want and need—both during and after the sale—by properly structuring the transfer of their businesses, even if the businesses’ valuations do not justify the income provided. Additionally, we can design the transfer so that owners retain control of their businesses during the buyout and until they are paid the full sale price.

2. Time: If a client does not want to leave the business immediately, we can structure the transfer to take as much time as necessary (typically, 5–10 years) depending on the owner’s goals, the successors’ abilities, and the business’ readiness. This allows owners to exit on their terms, develop new interests, and prepare themselves and the business for life after the sale. It also allows owners to continue collecting salary, distributions, and perks while maintaining control until the transfer is completed.

3. Taxes: Owners who transfer their businesses to family enjoy unique tax benefits. Using these benefits allows us to help owners legally minimize or even outright avoid paying income taxes on ownership transfers to family.

4. Known Successor: When an owner’s children succeed the owner (rather than a third party), the owner can typically rest assured about his or her successors’ honesty, work ethic, and leadership and management skills.

5. Value-Based Goals: Owners often choose to transfer to children because it allows them to accomplish many of their value-based goals, including the following:

  • Continuity in the joy and satisfaction they gain from working with their children during and after the ownership transfer.
  • Offering their children greater employment and financial opportunities than anyone else.
  • Maintaining the business as the “glue” that holds the family together.
  • Fulfilling the expectations of children who have grown up in the business and who know, want to stay in, and, one day, run it.
  • Reaping considerable (and justifiable) satisfaction from family traditions and values that benefit family, employees, customers, and community.
     

Challenges of a Transfer to Family

Though transferring a business to family seems to have many advantages, why do so many family transfers fail so monumentally? Most transfers to family fail due to one or more of the following reasons, each closely related to the benefits mentioned above.

1. Financial Security: Transferring a business to family can have negative consequences if the successor cannot or will not run the business properly. Poorly prepared or inadequately talented successors can destroy a business and former owner’s financial security. When owners transfer voting majority to family members before achieving financial security and/or before their successors are fully prepared to run the business, they run the risk of financial ruin.

2. Time: Compared to transfers to third parties or employee stock ownership plans, it takes much longer for owners to receive the full sale price when transferring their businesses to family. As Exit Planning Advisors, we must be vigilant in explaining to clients that full payment, especially from children, may take years, which can expose owners and their Exit Objectives to increased and sustained risk.

3. Taxes: Without careful planning, owners can end up paying more in taxes through a transfer to family than need be, especially in terms of income, estate, and gift taxes.

4. Questionable Successor: Transferring to family, especially children, raises tough questions about the successor’s ability to continue our clients’ success. Thus, we as Exit Planning Advisors must pose several difficult questions to our clients:

  • Does your designated successor share your vision of the business’ future?
  • Will the choice of your successor please the other members of your family?  If not, then what?
  • Can your successor match your desire, ambition, and aptitude for running the business?
     

If your clients cannot be sure whether their successors can run the business without fights or squabbles with others in their businesses, you may need to ask them to reconsider this Exit Path, lest they want to stay in the business past their planned exit date while reentering the parenting business.

5. Value-Based Goals: As many Exit Planning Advisors have experienced, poorly planned and implemented transfers to family can destroy both businesses and families. Thus, you must approach owners with the following concerns:

  • If children don’t get along with each other when they aren’t working together, can owners expect them to behave well when they are forced to work together?
  • Transferring ownership of the business to children often increases existing family friction, including perceptions of unequal treatment among siblings, between parents and children, and between owners and their spouses.
  • Communication among family members is emotional in a way that is uniquely different than the emotions present during sales to third parties. If Exit Planning Advisors do not manage communication early, correctly, and continuously, it can create or add fuel to family discord.
     

Each of these challenges can be overcome. You will need to address each challenge with your clients frankly and honestly and help them create a written, comprehensive map to face each challenge directly. This map should take owners from where they are (running a successful business) to where they want to be (living a happy, financially independent life and watching their family successors continue their success).

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