The Complexities and Issues of Business

A chief concern for many business owners is how to arrange the orderly transfer of business to the next generation of family members or key employees. By far the biggest concern is how to keep the family business and the family. It is estimated that more than 70% of family-owned businesses do not survive the transition from the founder to the second-generation.

There are essentially three levels of the business succession plan.

Management; this is day-to-day management of the business which can be left to one person, one child or a group  of children. Also, this group might not be active in the business. This group could also include key employees rather than family members

Ownership; most owners would prefer to leave their businesses to the children that are active in the business. However, not all the children might be involved. Owners would still like to treat their children fairly, but not necessarily equally. Consequently, if the business interest is not left to a group of children, some other value would be left to the non-business children. A subset of this topic is whether the business owner will need a continued economic benefit from the business after the transfer. Also, will the business owner continue to control the business after the transfer is complete.

Transfer taxes; estate taxes can erode business value.   The question would be is there enough liquidity to take on the debt and keep the business going? This is truly a challenge to high-value business especially with a estate tax being a moving target as to the exemptions and percentage of taxations.

 Level I management

It might take many years for an owner to train the successor management team so that the business can run automatically. This allows the owner to walk away from the day by day operations. To do this the owner must give up control and tasks in which they ordinarily controlled. This is easier said than done. Whether the owner creates a management team with the next generation, or a key group of employees, the owner must learn to delegate important tasks.

An important awareness for the business owner would be to focus on people issues. Future leadership is likely to be one or more of the children. The business owner must take steps to ensure that the leadership has the support of the key employees and other family members. This is done generally by a gradual transfer of roles and responsibilities to the successor. This gives the family member time to grow in their new position and allows business owners some time to get used to the diminishing role. A long timeline is important to a successful transition.

Family-owned businesses, for the most part, are very dependent on one or two key employees. They are critical to the success of the business and are needed for the continuing success of the business. Consequently, the succession plan should address methods to guarantee that key employees remain with the business upon the death, disability or retirement of the business owner. It is in the best interest of the family to keep the experience key people involved with the business.

This can be done by the following methods;

Employment agreements – this sets forth the employee’s duties and compensation and fringe benefits.  There can also be a benefit which we might call a stay on bonus. There also might be a non-compete clause.

Nonqualified deferred compensation plans; this is a benefit especially designed for the key person in many cases with a vesting schedule for a specific period of time. The longer the period the richer the benefit. To fund this program, life insurance contracts can be used, or phantom stock plans. In exchange the employee voluntarily promises not to terminate employment prior to retirement date.  This can also include a non-compete clause after the employee terminates or retires.

Stock option programs; this is a contract between the company and the employee and gives the employee the right to buy a specific number of company shares at a fixed price and within a certain period.

Change of control agreement; this basically sets in motion should there be a change to the control of the business.  This change will not alter the agreements with the employee with regards to  compensation and benefits. It will not adversely change for a set period such as 3 to 5 years following of the transfer of the business to the next generation or new ownership.

It would not be unusual for the company to create an advisory board. This is to assist the success and manager during the transition period.

Level II Ownership

Major concern for family business owners who have children that are active in the business is how to treat all the children fairly in the business succession process.  In doing so the business owner might be concerned with giving up while at the same time trying to guarantee a sufficient retirement income for himself.

Some of the following techniques to accomplish this;

Sell the business to the active children.

Gift and sell the business to active children, but deliver voting shares only  to the active children and nonvoting shares to the inactive children. This allows the active children the right to call (purchase) the nonvoting shares of the inactive children. Also, the non-voting children can have a put (to sell) their nonvoting shares to the active children.

Gift/or sell the business to the active children and leave the inactive children nonbusiness assets.

Create a Buy and Sell Agreement between the active children and the current owner.

If there’s more than one child active in the business but the business owners not certain which child should have control over the business a living trust can be established, which would give voting shares to one or more of the active children at the death of the business owner.

Level III – transfer taxes

 This involves strategies to transfer ownership of the business while minimizing gift and estate taxes. Unanticipated federal and state estate taxes can be so severe that the business may need to liquidate because of a tax liability.

Gifting techniques

  •  Annual exclusion gifts
  • Gift tax exemption – beyond present interest gift value
  •  Gifts to family LLC interests
  •  Gifts to trust
  •  Gift to charity and corporate repurchase
  •   Sales strategies
  • Installment sales
  • Private annuities
  •  Self-canceling installment notes

¨  Along with the above techniques certain “freezing techniques” can also be used along with discount. Such as Grat’s, LLC, GRITS.

 

 

 

 

 

 

 

 

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