Passing the Torch

In most family owned businesses there will come a time when the owner, in many instances the parent founder, will have to sit down and plan for the future of the company in his or her absence, with most proprietors wanting to see their business continue to flourish and recognising that passing it on to family members may be the most ideal and responsible option.

Proper planning is crucial for family businesses to avoid facing an uphill battle on the road to longevity and continued prosperity and, following years of hard work to establish a business, there are various reasons why one should consider what should happen to the family company after retirement.

Besides the security and certainty of knowing the prospective of the company, succession planning has several other benefits, including, the treatment of children and heirs in an equitable manner, the maintaining of control by the parent owner until he/she feels comfortable with passing it over to a child, the securing of post-retirement income, the minimising of any arising taxes and the enabling of flexibility, allowing for the owner to consider options and determine what may be best for the company.

Structuring the Transfer

There are a variety of ways in which an owner parent can decide to pass along the family business and the different methods tend to get very complex and have various repercussions relating to taxes and income.

Whilst I shall be providing a brief overview of possible modes of transfers, the purpose of this article is to give a broad and general outline of the ways in which a business can be handed down and, thus, should not be deemed as encapsulating all the nuances of the transactions.

Leaving the interest in the business to the children in a will, for instance, is relatively simple as this allows the owner to maintain complete control of the business during his lifetime. However, there may be downsides to this method in that some business owners may think that their children will benefit from having an ownership stake in the business whilst the former is still alive so as to learn to manage it at such point in time, whilst other proprietors worry that as they get older they might no longer be competent to fully run the company’s affairs.

Another option is that of donating all or part of the business to the offspring whilst the owner is still alive, with any future appreciation in the value of the business being excluded from the estate upon succession.

Others may choose to transfer the ownership of a business to the children while they’re still alive on condition that they will continue to receive an income from the operations of the business. In fact, in cases where the children might not have enough financial assets of their own to buy the business for its fair market value, an option would be to transfer the business on loan to the successors and hence resulting in an advantage to the owner as he/she will secure a steady stream of income from the principal and interest from the loan.

Buy-sell agreements are ideal for those business owners who have selected the person they would like to transfer the business to but who are not quite ready to hand over the reins. In a buy-sell agreement a business owner can specify that after a triggering event, such as retirement, incapacity or death, the designated successor will be required to purchase his or her interest in the business.

One may also choose to sell or give an interest in the business to a trust for his/her children’s benefit. In such instances, it would be imperative for the trust agreement to contain carefully-drafted provisions concerning the operations of the business and how ownership decisions get made if the owner suffers a disability, illness, or passes away, even.

Of course, all of the above scenarios can be combined in various ways, for instance it can be arranged for the transfer of a business interest to be partly a gift and partly a sale, and for owners not comfortable with giving up control, a possibility would be to split the ownership of the business into voting and non-voting interests, with the latter being transferred initially.

Whatever choice is made, a smooth transition can be the crowning legacy of the years of care and effort and it is in an owner’s best interest to obtain legal advice and engage a tax expert while in the process of business succession planning so as to understand all consequences of a certain option, particularly how decisions made may have an impact on any tax obligations.

Considerations

Tax related

The tax implications arising in the above highlighted transactions would have to be considered, of course. However, it is not the scope of this article to delve into same and at this juncture I wish to simply point out and draw the reader’s attention to the fact that specific provisions to Stamp Duty relative to transfers of family businesses have been very recently enacted.

Retirement income needs

In cases where the plan is to sell the business, determinations should be made as to how much income the owner will need in order to support his/her lifestyle and retirement goals before starting any negotiations. To resolve this, even after receiving a lump sum from a sale, many former business owners choose to stay involved and earn income by serving on the board of directors, giving consultation or even continuing to help out in day-to-day operations in a reduced but vital role, such as serving clients who have been with the company for years. Where an office building or other physical assets are owned, another option for generating retirement income would be to retain such assets and lease them back to the business.

Further considerations

Finally, there are many factors that should go into a proprietor’s decision about what to do with the family business upon retirement, including, how much effort it will take to adequately train the successor, whether the successor has what it takes to run a business, how other employees will take to the decision of transferring the business to a family member in particular, whether the successor will be able to maintain the current customer base and what is to happen if the ownership is passed to one child over others who may be less qualified for an ownership position. Such circumstances, together with others, need to be well tackled and resolved.

Final Thoughts

Business succession planning is all about creating a smooth, successful transition of company ownership; this is by no means a simple process and the areas that need to be considered are plentiful. There are familial, financial, and personal ramifications for any decisions made that should be dealt with carefully and, in this context, it is recommended that a business owner in the process of drafting up a business succession plan consults with lawyers, including tax advisors, to fully understand the options and handle the transfer in a professional way.

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