Father's Day Reflection

This Father's Day, I'd like to share a personal story. In 1934, my grandfather started a business in New York City to manufacturer children’s coats. He was very successful, but he died in 1972 without having properly planned how the business would continue on without him. My father, who had worked in the family business his whole adult life, was not prepared to take over the business, nor did he have the requisite skill set. Twelve years after my grandfather died, the business was finished, having closed its doors in 1984. Estate taxes were not the culprit. Instead, neither my grandfather nor my father ever created a business succession plan, nor did either have an exit strategy.

Roughly 90% of American small businesses are family-owned. Sadly, the majority of these businesses will fail to continue on to the next generation. In fact, only around 1/3 of all family-owned businesses survive into the 2 nd generation and only a small fraction of those make it to the 3rd generation or beyond. Sometimes, this is because the subsequent generations don’t have an interest in inheriting or running the family business. Other times, as was the case with my father, it’s because they don’t know how to run it. The problem in either scenario is the same: a failure to plan.

Why Business Owners Don’t Plan

While many business owners have the intent of passing on the family business to one or more of their children, they are often too busy running day-to-day operations, and simply do not have the time or energy to consider business succession planning. Moreover, the stress of identifying and then grooming a family member or employee you trust to take over your business is a potential hot potato for many families and is therefore often avoided. However, procrastination can be disastrous. Aside from procrastinating, here are some other ways that owners unintentionally sabotage business succession:

  • They mistake succession planning and exit strategies as one in the same.
  • They don’t obtain the proper valuation of the business.
  • They fail to identify a succession team.
  • They don’t integrate their business succession plan with their estate plan.
  • They ignore the Four Ds: Death, Disability, Divorce and Departure.
  • They treat the business like family rather than a business involving family.
  • They fail to diversify their net worth from the business as a whole.
  • They don’t plan for ALL contingencies.

Strategies for Success

There is no quick or easy answer or solution. However, in most successful transitions to the next generation or the third-party desired successor, owners have taken the necessary business succession and estate planning steps to minimize the conflicts, minimize estate and income taxes, and insure that the business is in the right hands to maximize the chances of its success. Comprehensive business succession and estate planning is the best way to improve the odds that your company will continue when you are gone (and possibly to provide the funds for your retirement, if you want to stop work while you are living). Moreover, if a family member is not going to run the business when you are gone, then plans must be made for the family business to be sold to a third party, either at your death or when you exit your business.

Tax Considerations

Remember that estates in excess of the amount that passes free of estate tax, currently $11.7M, are subject to a 40% Federal estate tax (plus state estate tax, if you live in D.C. or Maryland, but not Virginia). Thus, when doing your business succession and estate planning, you must plan for the need to pay the estate tax. Where is the source of funds to pay the estate tax? Do you need to plan for liquidity at death though estate tax planning and/or purchasing life insurance? The solution to all of this may be setting up a structure within the estate plan that assures that the those in the business own and control as much of the business you want, while giving those not in the business other assets (or just an income stream from the business), so they can control their financial destiny, without interfering with the day-to-day operations of the business.

Other Things to Consider

  • How much is the company worth? This can fluctuate during the life of a business. Should you get an appraisal now?
  • How long do you want/need to stay involved in the business? Many times, entrepreneurs see themselves as the business and find it hard to let go. There are also cases in which the owner cannot step down because they cannot be without the salary, health and retirement benefits they have been receiving from the company. There are ways to plan to allow the owner to continue to receive an income stream, as a part time employee or consultant as the family business transitions to the next generations. Another technique is a deferred compensation plan to provide income to the founder. Alternatively, you can sell or give the business interest to a trust for family members will pay an income stream to the original owner.
  • How will the business’s digital assets be managed or transferred? So much of today’s business operations are being run and stored online – financial accounts, passwords, social media content, etc. Who will receive access to the business’s digital assets? How will they gain access and for how long should they have it? In the event that the owner passes away, these details should be spelled out in advance.

General Planning Ideas

  • Sell or give assets, possibly including interests in the business, to children (and others) while you are alive.
  • Purchase life insurance to provide for liquidity and/or to equalize the estate (the life insurance must be owned by an irrevocable life insurance trust).
  • Creating voting and non-voting interests in the business to allow for control to be given to one set of family members, while non-voting interests are given to those who are outside of the business.
  • Using one or more charitable techniques to minimize income taxes and maximize return.
  • Creating a buy-sell agreement between you and those children in the business (or with others).
  • Creating trusts or other structures that control the use of assets after your death or control how business succession is going to occur over successive generations.

The Bottom Line

You’ve spend too many hours creating and operating your business to allow for it to all fall apart at your death or in other circumstances. Business succession and estate planning is critically important to the future success of your business, as well as to your own personal financial health and wealth. The best Father's Day gift you can give to yourself is to meet with an estate planning attorney.

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