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Navigating the Intersection: Estate & Family Business Succession Planning

Do you know the proper steps of estate and family business succession planning to help ensure that your family-owned business remains in the family after you’re gone? Planning ahead for what happens when you aren’t around anymore is crucial, and failure to do so could be putting your family’s financial future in jeopardy.

Differences Between Ownership & Management Succession

One challenge of transferring a family-owned business is distinguishing between ownership and management succession. When a business is sold to a third party, ownership and management succession typically happen simultaneously. But in a family-owned business, there may be reasons to separate the two.

From an estate planning perspective, transferring assets to the younger generation as early as possible allows you to remove future appreciation from your estate, minimizing any estate tax liability. However, you may not be ready to hand over the reins of your business or you may feel that your children aren’t yet ready to take over.

There are several strategies owners can use to transfer ownership without immediately giving up control, including:

  • Placing business interests in a trust, family limited partnership (FLP) or other vehicle that allows the owner to transfer substantial ownership interests to the younger generation while retaining management control,
  • Transferring ownership to the next generation in the form of nonvoting stock, or
  • Establishing an employee stock ownership plan.

Another reason to separate ownership and management succession is to deal with family members who aren’t involved in the business. Providing heirs outside the business with nonvoting stock or other equity interests that don’t confer control can be an effective way to share the wealth while allowing those who work in the business to take over management.

Conflicts May Arise In Family Business Succession Planning

Another unique challenge presented by family businesses is that the older and younger generations may have conflicting financial needs. Fortunately, several strategies are available to generate cash flow for the owner while reducing the burden on the next generation. They include:

  • An installment sale of the business to children or other family members. This provides liquidity for the owners while easing the burden on the younger generation and improving the chances that the purchase can be funded by cash flows from the business. Plus, as long as the price and terms are comparable to arm’s-length transactions between unrelated parties, the sale shouldn’t trigger gift or estate taxes.
  • A grantor retained annuity trust (GRAT). By transferring business interests to a GRAT, owners obtain a variety of gift and estate tax benefits (provided they survive the trust term) while enjoying a fixed income stream for a period of years. At the end of the term, the business is transferred to the owners’ children or other beneficiaries. GRATs are typically designed to be gift-tax-free.

Because each family business is different, it’s important to work with your estate planning advisor to identify appropriate strategies in line with your objectives and resources.

Plan Sooner Rather Than Later

Regardless of your strategy, the earlier you start planning the better. Transitioning the business gradually over several years or even a decade or more gives you time to educate family members about your succession planning philosophy. It also allows you to relinquish control over time and implement tax-efficient business transfer strategies. Contact us to help assist you in the family business succession planning process.

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