Even if you've spent decades building a successful business, you may have yet to tackle one of the hardest decisions a business owner can make: business succession planning. Insufficient advance planning could damage your company's longevity, however, by placing it in the hands of a third party ill-equipped to lead it to prosperity, or with long-term goals that don't align with yours.
For many small business owners, family members may be their first choice to take over, but even this can come with serious considerations — and potential tax consequences. Whether you want to transfer the company to your son, daughter or another close relative, here's what you may want to consider when it comes to business succession planning.
Selecting a Successor
Forty-one percent of family businesses say they plan to pass their companies on to the next generation, but only 23 percent have created a comprehensive succession plan, according to a PricewaterhouseCoopers (PwC) survey.
Part of the challenge may be picking a successor. While it may seem like it's best to keep your business within the family, as a business owner you'll want to be really mindful about who you choose to take over.
First of all, consider your family members' interests in taking over the business. Your dream may not be theirs, and the person you pick to succeed you should have a passion for your company. Choosing a successor within the family may not be the best fit if no one has an interest in bearing the responsibility of the family legacy. If that's the case, you may decide to hire a leader from outside the company or promote a key employee from within.
Examine your goals for the business, whether they involve expansion, offering new products or services, or even focusing on your core offerings. Next, identify which family member (if any) has the right leadership skills to assume your role and help the business succeed long-term; these skills may include managing people, confident decision-making and the ability to identify good business opportunities. Personality is also important — someone who berates employees, has time management issues or leads like a dictator may not be the right fit.
You've had years to observe your family members, so you know them best. You might consider giving them increasing responsibility within your business to see how they handle potential challenges or key projects. Once you've had a chance to assess them more closely, you may be better able to make a decision about which person's abilities best match the company's needs.
Once you've identified the right person to take over the business, you'll want to start grooming him or her as soon as possible. It's generally best to begin mentoring, training and coaching your successor well before you actually need him or her to take over, making sure they understand all aspects of the business, including tasks and responsibilities that may not be part of their current day-to-day role.
Business Transfer Strategies
Picking a successor is only part of the battle. You'll also have to legally transfer the business and make sure you have all your plans in writing. There are several ways you can transfer your business to a family member, including:
Establishing a buy-sell agreement: Before you transfer the business, you'll want to determine your company's valuation, which will involve reviewing your assets, liabilities and revenue. You can then draw up a buy-sell agreement, which will include details on what should happen to your business in the event of your retirement, death or withdrawal due to disability. The final agreement will be between you and your successor and will detail your business's valuation and purchase terms for the sale of your company.
Transferring your business as a private annuity: Once a buy-sell agreement is in place, you can decide between several transfer strategies. As a private annuity, you can transfer the business, and in exchange your successor will make installment payments to you for the rest of your life. The advantage of a private annuity is that it may reduce your gift and estate taxes.
Transferring your business through a partnership: You can also create a family limited partnership, which is a legal structure you can use to transfer your business interest to your successor. With this structure, you'll have family members who act as general partners and assume more of a management role in the business. Limited partners who own shares in the business can draw a profit from it. This approach may work if you choose to name more than one family successor. It also allows you to gift your business interest to family members over time, which you can do tax-free as long as you don't exceed the annual limit for the gift tax exclusion.
Transferring your business as a gift: While you can transfer all of your company as a gift or just part of it, keep in mind that either way you'll be subject to gift and estate taxes, as well as capital gains taxes (which will be a 15 percent tax rate at minimum) if you sell the business before you die. You may want to consult an accountant and/or an attorney about the best way to structure your business transfer to reduce your tax liability.
It's critical you choose the right successor to push the business to succeed after you're gone. Having a business succession plan in place years before you need it is a good way to help ensure your business ends up in the right hands — and transitions smoothly from one generation to the next.