Will Your Family Business Fail Without You? Odds are yes, but it does not have too. Estate Planning—Part 3 Business Succession Planning
Did you know that Americans create over one million businesses every year? And, that out of those one million new business 80% fail within five years? It is hard to build a business that succeeds even with help it is equally hard or hard to pass your successful business to the next generations. Businesses passed to the next generation only about 30% survive the second generation. 30% is great, however, when compared to the 12% that are still viable into the third generation. Your business surviving into the fourth generation or beyond is an abysmal 3%.
You may not want your business to last for multiple generations, and there is nothing wrong with that outcome. I assume, however, you would prefer to sell your business, and (either in your lifetime or upon your death) not have it go belly up. Or, you may want your business to remain within your family. You may want your family or part of your family to manage the business. You may want your family or part to own part of the business. No matter your desired outcome, careful succession planning of your business will help meet your goals and protect the business and your heirs from potential large, unexpected tax liabilities and other unforeseen expenses.
What is Succession Planning?
A succession plan is a documented roadmap for partners, heirs, and successors to follow in the event of your death, disability, or retirement. It can include a plan for distribution of business stock or other assets, debt retirement schedules, life insurance policies, and buy-sell agreements between partners and heirs. Besides documenting assets, the plan can and should provide for the division of responsibilities among successors. The plan can include any other elements that affect your business assets. The plan may also establish the value of your business.
So where do you start? You must first clearly set your goals and objectives for your succession plan. Next you determine the company's current human and financial resources. Then there are several questions you need to ask yourself.
Do not forget: While clarifying your goals and wishes is important, it is not enough. You also need to communicate your vision with your family, business partners, and key employees. If nobody knows the plan exists how can it be followed? Remember an effective succession plan is flexible since you do not know the future it should be able to be changed as new situations arise.
Creating a succession plan
At a minimum, a business succession plan should address the systematic transfer of the management and ownership of a business.
Management succession planning may include:
Ownership transfer planning considerations may include:
Succession Planning Strategies for your Business
There are many different methods, types of succession planning vehicles. Each has their positives and negatives. I will not attempt to explain them all, but will discuss a few. I would strongly suggest seeking counsel from an Estate Planning Attorney or Tax Attorney to see which is best for you and your business.
Strategies to minimize taxes and avoid probate costs.
The gap between the value of your business and the liquidity of your business are two very different figures for most. Since the value of the business is what is taxed not the liquidity this causes a significant problem. This problem, however, can be addressed and managed by creating an Irrevocable Life Insurance Trust “ILIT.” If the ILIT structure meets the requirements set by the IRS, the benefits paid from the underlying life insurance policy do not pass through probate and are not subject to income or estate taxes and are available immediately. This provides your business and heirs the liquidity to pay any estate taxes and other expenses, instead of having to sell assets or the business to be able to pay the taxes.
You may be able to transfer your business assets to your children and retain a source of income for yourself by establishing a grantor retained annuity trust (GRAT) or grantor retained unitrust (GRUT). If the assets grow over the terms of the trust, the appreciation will not be subject to estate taxes, so these trusts can be useful tools for passing on a rapidly growing business. To achieve the desired estate tax benefits the trust must be structured precisely, and you must outlive the terms of the trust. You may mitigate this risk by structuring an ILIT for wealth replacement to help offset the potential tax liability that would occur if you die before the trust expires.
Another approach is the family limited partnership or a family limited liability company. For example, you can form a limited partnership to hold the business assets. Some of the limited partnership units can be transferred to your successors, potentially eliminating the units from your taxable estate and reduce the value of your estate potential excluding the rest of your estate from estate taxes. Because limited partnership interests do not carry control of the partnership, the value of the transferred assets may be discounted for gift tax purposes. As with GRATs and GRUTs, family limited partnerships are subject to complex rules, and it is advisable to consult with experienced tax and estate planning professionals.
You worked hard to create a successful business you should protect the value you have created from it being squandered. The likelihood of Uncle Sam taking more than he need or deserves is high. A forced sale to pay the taxes will likely result in a purchase price well below the actual value and your heirs to pay more in taxes than what they received, due to the discount sale. Please, if you have created and or grown a business do not let the value you have provided to your community, state, and country be lost when the inevitable happens.
Benjamin F. King
My goal is to bring issues that are often over looked. But, this blog is not legal advice it is only for general information. Each situation is fact specific.