Every leader will transition out of their business at some point; that is a certainty. Planning for that transition is not.
Most business owners have what amounts to a contingency plan to cover an unexpected transition, such as a death. But that’s usually not an orderly way to transition a business to the next generation of leadership, and the business owner and their family into their next chapter. More significant tax implications exist for a transition that isn’t well thought out, both in terms of income taxes and potentially estate taxes. A more thoughtful plan is needed.
“Many owners think having a plan locks them into irrevocable decisions, leaving little flexibility on timing or ability to make changes. But that’s not the case,” says Bethany Bryant, Regional Managing Director of Glenmede. “Ultimately, an imperfect plan now is better than no plan at all later.”
Smart Business spoke with Bryant about the importance of creating a business transition plan well ahead of time.
Where does a transition begin?
Business owners should first address their desired transition, then ready the business to navigate that plan. Understanding the value of the business is also a key piece in determining options for the financial and estate plan, and is a step towards the execution of that transition.
Those who don’t have some view of their ideal outcomes should build a team of professionals — wealth managers, attorneys, accountants and other professional advisers — to help construct an exit plan. There’s no one-size-fits-all solution, so they’ll ask questions about what’s important: for instance, keeping the business in the family or not, retaining cash flow after an exit, or converting the business into other forms of wealth that they can pass along. Then they’ll construct a plan that ensures those goals are met.
Owners can tailor a plan that keeps them involved and in control of the business, even while they are transferring ownership interests to other entities, trusts vehicles or individuals. And owners who have some children working in the business and others who aren’t can discuss equal vs. fair options for dividing business interests, particularly if the business constitutes most of the family wealth. The company can be sold or gifted all at once or little bits at a time to family members, employees or third parties. It all comes down to the owner creating a vision and working with professionals who can help implement a plan to achieve it.
What strategies can help address transition concerns?
Owners looking to take chips off the table while still maintaining control over the business could use valuation discounts — discounts for a lack of control or lack of marketability — that come with transferring minority shares. This is a great technique when gifting shares to family members, or even selling to a non-family member. Transferring shares to certain trust entities can also allow for control of the business.
Life insurance can be used to equalize an inheritance when some family members are in the business and others are not. Annual premiums can often be paid by the business and the insurance can provide a windfall at death to parties not working in the business.
Installment sales can offer the exiting owner a stream of cash flow as they sell their shares. They are also useful when internal partners or family members don’t have the cash flow to buy the business outright. Paying it off over a period of years is often easier for these buyers.
An owner could also divide the business assets into separate entities and lease back the use of those assets for cash flow. For instance, separating the real estate from the operating business creates ownership division while producing a stream of income if leased back or transitioning assets to different individuals.
Business owners who don’t have a plan should talk through options with their advisers and put a strategy on paper sooner than later. Transition planning often takes longer than anticipated. For every challenge, good advisers can find techniques to overcome it.
This article presents general information and is not intended to be financial, investment, tax, legal or other advice. It contains information and opinions which may change after publication. Views expressed herein do not necessarily reflect the views of the author’s employer. No outcome, including performance or tax consequences, is guaranteed, due to various risks and uncertainties. Readers should consult with their own financial, tax, legal or other advisors to seek advice on their individual circumstances. ●
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