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Exit Planning

Planning for When ‘Stuff Happens’ in Business Transfers to Children

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Planning for When 'Stuff Happens' in Business Transfers to Children

You’ve delivered the perfect Exit Plan to your family-business-owner client.
 

You’ve based it on her objectives and existing resources, analyzed the pros and cons of various strategies to reach her objectives and have reached a consensus with the owner and all of her advisors on how best to reach those objectives.

And then something changes. Your perfect plan is suddenly worthless. Why? Because you forgot to include a Plan B, well two Plan Bs: one for the owner and one for the successor owner.

While preparing for any type of exit, circumstances can—and often do—change. Intergenerational business transfers are no exception. That is why having backup plans—both for the owner and his or her successors—is crucial.

Let’s first look at the most common events that cause owners to activate a Plan B.

A Backup Plan For The Owner
 

  • If owners die or become incapacitated before they complete their transfers, their estate plans (wills and trusts) must effect the transfer of the business to the child(ren) of their choice.
  • If a business is so valuable that the child cannot financially manage a buyout, and gifting the business to that child would result in unacceptably high taxes, you might suggest that owners sell some or all of the business to a third party, and/or transfer a considerable portion to a charitable trust or organization.
  • If a business-active child is able to acquire ownership of a valuable business, have you put in place a means for the owner to provide assets of appropriate value to the other children? Fairness, as the owner defines it, is a determining factor here.
  • Over time, some businesses become too complex or too sophisticated for any one person to run and control. No child can be expected to shoulder that burden successfully. If the owner has not created a professional management team to operate the company for the benefit of his or her family, the best alternative may be to sell part, or all, of the company to a third party.
  • As time passes, we may find that the business-active child does not possess the drive or interest necessary to run the business successfully. His or her desire to please may have blinded you and the owner to the child’s lack of ability or willingness to assume risk. Or, the child may not have fully understood the personal and financial sacrifices necessary to maintain the success of the business. If this happens, a sale to a third party, or to management, may be a better option.
  • Finally, as parents and child move through the transfer process, substantial differences in management style and practices can emerge. Sometimes these differences can be overcome but often they are so great that the transfer cannot be completed. If a transfer falters, the company must have the ability to reacquire the business-active child’s ownership interest at the lowest defensible price. This is best accomplished through binding buy-back agreements between the company and business-active children.

Those are some of the “owner-oriented” triggers for a Plan B, but don’t forget those events that can affect the business-active child (or all of the owner’s children).

Backup Plan for Successor Owners
 

There are some situations in which a plan to leave a business to more than one child creates a ticking time bomb for them and the entire family. Bombs of this type typically explode after the owner leaves. Why?

  • The kids can’t share the business after all. For this reason, the new owners (children) should have their own backup plans should one child leave (on good or bad terms) after receiving ownership. This means you must create an agreement to manage this situation when the owner makes the first transfer of ownership to multiple children.
  • One child wishes to transfer ownership to his or her children, but the other owner-children object to any transfer that doesn’t first give them the right to acquire ownership.
  • A majority of the new owners wants to sell to a third party, but one child-owner objects.
  • A business-owning child divorces.
  • The business-owning children disagree on the future path of the company.

You and your owner/clients must consider and address these possible scenarios (and many more) before children receive substantial ownership. You will incorporate the owner’s decisions into agreements (such as buy-sell agreements among the incoming owners) between the owner and the children. For example, you may recommend that the owner write into her estate plan that she (or her estate) retain a first-right-of-refusal should one or more of the above situations occur.

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Which Event Triggers Plan Bs Most Often?
 

From the list above, can you pick which event is the most likely to affect the transfer? If you choose the divorce of a child who has received, by gift or otherwise, ownership of the company or ownership of family assets, you are correct.

You must employ tools (such as trusts and other entities to protect the business and other assets from an involuntary transfer of ownership. These tools can protect these assets from creditor (including ex-spouses) attack. As you know, many of these tools also serve to avoid or minimize estate taxes for your client’s children and their heirs.

Conclusion
 

If the Exit Plans you are creating for family transfers don’t include backup plans, you’ve got a little more work to do. If they do, you know that backup plans are an integral part of comprehensive planning for family-owned enterprises, owners and their families.

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