If you intend to name a family member to succeed you in running your company, you have some advantages. The person you’ll name (potentially your son or daughter, son- or daughter-in-law) is someone you can identify easily, without an extensive search. You know that person’s capabilities and shortcomings; he or she likely works for the company now, so you have a good idea of how well the future owner will do.
That said, passing on your company to a family member can pose problems. Intra-family dynamics should be considered, which may not be the case if your successor is an outsider. Moreover, there are several methods of relinquishing ownership, all of which may be closely scrutinized by the IRS.
Seeing Things Clearly
Designating a family member as your successor can raise emotional issues. Does your potential successor really want to run the business, working the long hours you’ve always put in? Is your potential successor truly eager to jump off the partner track at their law firm to take charge of your company? Honest assessment of these considerations are essential, even if they lead to painful conclusions.
Example: Donna Allen realized that her two sons did not get along with each other, but she thought that would change as they grew older. Instead, their mutual animosity continues, and they’re competing to replace their mother as CEO of Allen Enterprises. Facing reality, Donna concluded that a 50/50 ownership solution would ruin her successful company. Thus, she is dividing the company into two firms, along product lines, so each son can be the sole owner of his own business in the future.
If you have more than one child, it’s often the case that one will be the obvious successor. Passing on ownership to all the children and leaving one to run the company can lead to strife: The operator may feel like he or she is working to enrich siblings, and the outside owners might second-guess business decisions.
Naming the child who will manage the company as the sole owner may make sense, from a business perspective, but it can also deprive the remaining children of a valuable asset. In such cases, it may be desirable to equalize the inheritances (if you’re married, your estate plan should also provide for a surviving spouse).
Everyone’s specific circumstances are unique, but life insurance may offer a way to compensate family members who won’t end up with your valuable business.
Your estate plan should also encompass the method used for keeping your business in the family. Below is a broad overview of your options:
Sell it. This method has the obvious benefit of providing you with income for retirement, enabling you to enjoy the fruits of building the business. Coming up with enough cash for the buyout may be difficult for your younger successor, so it may be necessary to arrange financing or an installment sale so payments will come from future earnings of the company, in some form or fashion.
Give it. Another option is to transfer some shares to your successor during his or her lifetime. Gift taxes can be avoided or minimized by using valuation discounts for minority interests in the company. On the downside, such gifts can reduce the income you’ll get from the business and you should have a strategy for dealing with other children.
Leave it. You can simply hold onto the business until death and bequeath it to the successor under the conditions of your will. This approach allows you to remain in control and perhaps receive income from dividends once you stop working. A lack of ownership, however, may discourage your chosen successor and lead to that person’s leaving for another opportunity.
No matter which of these methods you choose, the IRS may challenge the valuation involved. A below-market sale, for example, could be recast as part sale and part taxable gift. Thus, having a reliable valuation of the company should be part of your “all-in-the-family” succession plan.
A sophisticated approach may involve a mix of selling, giving, and leaving your business to a younger relative. Tactics such as retaining income-producing shares while transferring operational control may be appropriate. My office can assist you with putting together a tax-effective strategy.