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Keeping it in the Family: Business Transition Planning

By Holly SwanExecutive Director, Advisor Institute

Regardless of whether a family business has apparent heirs or children working in management roles, you can help business owner clients understand their options for passing the company on to the next generation.

Transfers to the next generation are typically accomplished through sales, gifts or a combination of the two. Let's take a look at the different options and how they work.

Transfers of Voting vs. Non-Voting Interests

What it is: Business owners can decide how much control their heirs will have over the business by choosing to transfer either voting or non-voting interests in the company.

How it works: Family members who are unable or uninterested in managing the business can receive an economic-only interest in the form of non-voting interests. In the case where some children are involved in the day-to-day operations and others are not, different forms of ownership can be given to each. In cases where no family members are involved, outside management can be used to run the company.

Direct Transfers

What it is: Business owners can choose to gift or sell shares directly to their children.

How it works: Direct transfers to children are typical when children have shown a high degree of financial and professional responsibility and where there aren't any concerns about managing a federally taxable estate.

Direct transfers in the form of a sale might be a good option for owners who need proceeds to fund living expenses in retirement. This can be done through the use of a promissory note with payments being funded by the company's profits or through traditional financing.

For owners who are less reliant on the value of the business, they may choose to gift a portion of the company directly to the next generation with the option to hold back an interest that generates profits to cover living expenses. Remember: lifetime gifts in excess of the business owner's remaining unified credit will be taxable.

Transfers in Trust

What it is: Business owners can choose to gift or sell shares to a trust for the benefit of their children and/or future generations.

How it works: Gifts or sales of assets to a trust, instead of outright, are common when the business owner wants the company to be held for the benefit of future generations. In that case, a generation-skipping trust might be used. Gifts or sales to trusts may also be utilized when the business owner feels there is a benefit to a trustee controlling the company interest for a period of time.

As with outright transfers, determining whether a sale or gift is the best option comes down to a number of factors, including: 1) the business owner's need for funds, 2) the value of the business, and 3) the owner's remaining unified credit.

Hybrid Options

What it is: A hybrid transfer is a combination of a sale and gift, either outright, in trust, or to one or more third parties.

How it works: A hybrid transfer could take a couple forms: 1) a partial sale to company management, or 2) private equity could be used in combination with a gift or sale to children. Alternatively, the business and the physical building in which it resides can be transferred separately to generate a rental stream for the family.

When it comes to a family business, keeping it in the family has its advantages. You can be the catalyst for helping clients proactively plan for and establish their business' legacy.

Bottom line: Help family business owner clients understand the intra-family transfer options available and encourage them to reach out to their tax and estate planning attorneys for help in identifying the best one based on their planning needs.