Are you planning to retire from a family business or know someone who is?
One of the most significant challenges to the owner of any family business is planning for the future and how to best transfer share ownership to the next generation to ensure the business continues and provides family security for surviving family members. Business owners should also consider estate planning issues if there are children who are inactive in the family business.
Without some form of succession plan there is a risk the business can become paralysed when the owner departs, particularly if it is unexpected.
By not planning ahead owners run the risk that their business will not get to the next generation, or will lead to debate and stress among many people.
Many family business owners do not consider the implication of share ownership or succession planning because they are too busy building and running their business.
In most instances business owners leave their estate and business for the benefit of their spouse, with provision for it to be distributed equally among the children when their spouse passes on. However, this approach can lead to disaster depending on who participates in the business. A family member working in the business could believe it unfair to share equally with a family member employed outside of the business.
Removing yourself from the business: what are some of the options?
To minimise stress and disagreements between siblings, the business owner needs to differentiate between active and passive family members.
This may include:
- Leaving a majority of shares to the active members of the business
- Having the business valued and selling the business to their children.
For owners who do not want to risk their retirement security and are not sure that their children want, or are able to run the business successfully the following options is available:
A leveraged buy out whereby the business borrows the money to buy out the owner. In order to do this there must be sufficient cash flow to service the new debt, and the owner may be subject to tax on the gain, as though the business were sold to outsiders.
This approach ensures the owner is secure with cash, and the children can continue the business, for better or worse.
For owners that have both active and inactive family members consider:
- Leaving assets to inactive members instead of dividing the business in equal parts. This could include real estate or security investments.
- Providing life insurance options small amounts of shares can be gifted to the active children and the company can take out a life insurance policy on the life of the owner. On the owner’s death, the proceeds of the life insurance can be used to redeem the remaining shares from the owner’s estate.
This then leaves the business in the hands of the active children while also providing enough cash for those who are inactive.
Taking care of yourself
To ensure the business owner is not reliant upon the family business to supplement their income in retirement, they need to consider if they and their spouse have significant assets outside of the business to guarantee their own security following their retirement.
This means that their security is not dependent on the future success of the business that has been passed on to their children.
Succession planning for a family business is not easy. However planning ahead can lead to excellent outcomes for all involved. If you are a business owner, it is important that you consider these important issues.