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Should You Leave the Business to a Family Member?

03/28/2016 Ely Friedman

Did you know that 9 in 10 American businesses are family owned and operated? And yet surprisingly, nearly 7 in 10 of these businesses don’t currently have a proper plan in place for the smooth transfer of managerial power should the owner retire, fall sick or die.

“Succession planning is just as important as estate planning or getting your will up to date,” says Donnie Houston, founder of Houston and Company, a financial advisory firm in Duluth, Minn.

Although a succession plan should be established early in the life of any business, “the reality is that people tend to put it on the back burner,” Houston says.

When a child who is currently involved with the family construction business agrees to take over the reins once the owner steps down, tools such as a shareholder agreement and/or stock-recapitalization plan – as well as using a trust to help facilitate these needs – can help ensure a successful transition of power.

Develop a shareholder agreement

Drawing up a shareholder agreement is a good place to start. This document safeguards against common problems such as a forced liquidation of assets, while facilitating the transfer of managerial control.

It also specifically names a designated successor who would step in to take control of the company’s day-to-day operations upon the death or retirement of the owner.

In a situation where only one of several children is active in the firm, the shareholder’s agreement allows for an equitable distribution of the firm’s assets while still giving the employee child the necessary voting control over the company.

Provide stock recapitalization

Stock recapitalization is another plan that provides equal distribution of equity while limiting control of the business to active family members. This is particularly useful when the owner doesn’t want to leave a comprehensive set of instructions regarding managerial control.

In this situation, company stock is exchanged for two separate divisions of stock: voting and nonvoting.

Children actively involved in the business receive voting stock, while those not employed by the company are granted nonvoting stock. The monetary value of both classes of stock is the same. Under certain circumstances, the conversion of stock through a stock recapitalization plan may be considered tax-free.

Use a trust

Including a management succession plan in a trust that holds the company’s stock is yet another alternative.

The trust would serve the purpose of granting to the children a majority interest in the family business and would become effective either during the owner’s lifetime or upon his or her death. Furthermore, the trust could specify that an active child would become the trustee of the company and, in the process, retain voting control over the company.

If the trust was funded with company stock and personal assets, the nonactive children would be allowed to control their portion of the nonbusiness assets. However, only the active child who is designated as “special trustee” would be granted authority over the remaining business assets held in the trust.

Plan now for the future

Perhaps the most significant aspect of any owner-heir relationship is the need for the owner to stay connected to the business throughout the transition process, while at the same time transferring the asset out of his or her estate for planning purposes.

The good news is that even a small shred of attachment can accomplish this goal.

For instance, a business owner who transfers the company stock to heirs may still stay in charge of day-to-day operations by maintaining a mere 2 percent interest in a family limited partnership (FLP). One cannot overestimate the importance of a proper managerial succession plan when plotting the future of a family-owned business, says Tom McKinnon, executive consultant for Novations Group, a Boston-based consulting and training firm.

“Now more than ever, a management succession plan plays an increasingly important role in an organization’s strategy and stability,” McKinnon said.

Many family-owned businesses have been sold, too often for much less than they were worth, because there was no succession plan in place for leadership of the company. It has been estimated that, without a written succession plan, nearly 70 percent of family businesses fail to successfully transfer wealth.

Family business owners can stay up to date by consulting the Family Business Experts (www.family-business-experts.com), an online resource that includes access to current and archived articles from the monthly e-zine Understanding Family Business.

Here you’ll find a wide range of pertinent family-business topics such as succession planning and management, business valuation, how to handle family infighting and the proper way to construct a family business history. The site also offers an assortment of downloadable templates.

For additional information or guidance related to this article, contact Ely Friedman at efriedman@vlcpa.com or 800.887.0437.

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