Lines May Blur When it Comes to Estate and Family Business Succession Planning
Understand the complexities of estate planning for family businesses.
Source: Newburg and Co
Owners of closely held businesses typically have a significant portion of their wealth tied up in their enterprises. If you own a closely held business with your relatives involved, and don’t take the proper estate planning steps to ensure that it lives on after you’re gone, you may be placing your family at financial risk.
Differences between ownership and 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
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 minimizing 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.
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.
Questions people ask
What is the difference between management and ownership succession in a family business?
Ownership succession involves transferring the business's equity or assets, while management succession is about passing control over daily operations. In a family business, these can be separated, owners may transfer ownership interests but retain management control until the next generation is ready.
How can I transfer my business to my children without giving up control right away?
Owners can place business interests in a trust or family limited partnership, transfer nonvoting stock, or use similar vehicles. These tools let the next generation receive ownership benefits while the senior generation keeps decision-making authority until the timing is right for a full transition.
How can I treat heirs who don’t work in the business fairly?
You can provide heirs not involved in the business with nonvoting stock or equity interests that do not confer control. This lets them benefit from the business's success without shifting management responsibility away from family members actively working in the company.
Why is early planning important for family business succession?
Planning early gives more years to educate family members, resolve conflicts, and gradually transfer control. It allows business owners to transition at their pace, use tax-efficient strategies, and prepare the next generation for leadership and ownership responsibilities.