Over the years, many of us have seen family businesses pass from one generation to the next. However, the transition can be very difficult and is often filled with a number of obstacles. It’s common knowledge that while many businesses successfully transition from the first to the second generation, successfully passing it on to the third generation is rare.
The most important factor in successfully transitioning the business to the next generation is proper preparation and execution of a plan. It can take years to successfully transition a business to the next generation, so the sooner the owner and family start to plan their exit strategy, the greater the likelihood of a success.
In the first part of this exit strategy series, we will focus on one of the obstacles that an owner faces in transitioning the business to the next generation. That is, nearly all of the owner’s net worth is typically tied up in the business leading to multiple problems.
- Retirement Income - In order to exit the business, the owner must have sufficient income to retire. That means he or she must take out enough cash to fund their retirement. This is frequently accomplished by a combination of retirement plan contributions, continued salary or consulting fees, and a sale of the stock in the business to the next generation. The latter can be accomplished by a combination of the company buying back the stock or the next generation buying it from the parent.
- Equal Distributions – If the owner has more than one child, then the distribution of the company stock becomes an obstacle. For example, if the owner has three children and only one or two are involved in the business, then the non-participating children want their “piece of the pie.” Giving or selling the stock equally to all of the children can create some financial hardships and relationship issues for both the business and/or the children. As one person put it, how can two children who couldn’t share a $.98 toy now share a multi-million dollar business.
- Estate Taxes - If the value of the owner’s estate exceeds the unified credit, there may be substantial estate taxes due. Without proper planning, the business may be required to fund estate and inheritance taxes which can hurt the future prospects of the business.
In the next part of this series, we will look at the issues surrounding leadership in the transition.
In order to have a successful transition, the owner must consider their objectives in exiting the business and create a plan to meet those objectives. Owners need to consider engaging with an experienced professional to guide them through the process in order to keep the business running smoothly, guide the family through all of the obstacles they’ll face and coordinate the activities of the numerous advisors.