Transferring Business Ownership to Children

BigStockPhoto ©

After building a successful business, many business owners decide they want to transfer ownership to their children. This desire to share success with the next generation is no different from non-business-owning parents. However, the tools they can use to transfer wealth vary. Whether you own a business or not, the fundamental questions are the same:

  1. How much wealth do you want to keep for yourself?
  2. How much wealth do you want the children to have? How much is too much?
  3. What tools can you use to minimize the Estate and Gift Tax consequences
    of transferring wealth?

Business owners have to put those questions in the context of their exit objective. Once owners establish their financial exit objective, they can answer the universal questions above and design a transfer mechanism that will pass the wealth to the children with minimal tax impact.

Question One: How much wealth do you want when you leave your business?

The primary decision every parent makes when transferring wealth to children is not how to accomplish the transfer (that’s the estate planning attorney’s job), but how much wealth to transfer to children.

To answer that question, business owners must revisit their financial exit objective; namely, how much wealth do you wish to have after you exit your business? The amount of wealth owners wish to leave their children usually (but not always) depends on how much the owners wish to keep after they exit their businesses.

As a general rule, we discourage parents from making significant gifts to children until their own financial security is ensured. Only after the parents’ needs are met do we ask how much is enough – or too much – for the children.

The first step in creating a comprehensive exit plan is for owners to determine their objectives. Without goals, there can be no plan and owners are rarely able to leave their businesses on their terms.

Question Two: How much wealth do you want the children to have? (And how much is too much?)

For many successful business owners, the question of how to leave as much money as possible to children begs the more important question: Given the financial success of the business, how much money should the children receive and how much is too much?

A statement we often hear from our clients is, “I want to give the children enough money to do anything, but not enough to do nothing.” That’s a noble sentiment, but one difficult to execute – at least without careful planning.

When owners wrestle with the question of “how much is too much?” remember that children need not receive money outright. Rarely are large amounts of wealth transferred to children freely or outright. Instead, access to wealth is restricted through the use of family limited partnerships (or limited liability companies) and the use of trusts. These tools are primarily designed to reflect the parents’ desire to restrict their children’s (and their spouses’) access to wealth. This is true regardless of the amount of wealth the parent wishes to transfer.

Question Three: What tools minimize the Estate and Gift Tax consequences
of transferring wealth?

The key to transferring large amounts of wealth was discussed 2,000 years ago by the patron saint of estate planning attorneys, Archimedes. Regarding leverage, he observed, “Give me a place to stand and I will move the earth.” Using leverage to move the earth – or to move your wealth – is the key to achieving noteworthy results. As we have discussed in previous articles, each U.S. resident can give away, during his or her lifetime, a little over $11 million as well as the current annual gift exclusion. Working with trusted advisors to maximize the use of this gift exemption in conjunction with grantor retained annuity trusts (GRATs), stock recapitalization strategies, and charitable contributions is paramount to accomplishing your transition goals.

Answering these questions is only the beginning. Once they’re answered, the real work begins. Too often, owners assume that a transfer to children will go smoothly and simply, requiring little more than informing their children of the date they’ll be taking the reins. Owners who make this assumption commonly realize that without planning, they can harm their businesses, their business exits, and their long-term relationships with their families. Without proper exit planning, ownership transfers to children can produce negative consequences in several areas of your life.

Money – It’s likely that your children don’t have the capital to purchase their shares of ownership outright. This means that when transferring to a child, you’ll likely need to accept a promissory note and rely on your child to maintain or grow the company to receive your business’s full sale value. If something goes wrong, such as your child not having the ability to run the company as successfully as you did, you may receive less than what you expected from the transfer of your ownership interest. Since the goal of an exit plan is to position you to exit with financial security, transferring ownership to a child without a thoughtful plan can threaten that goal.

Another common money-related problem involves how you’ll parse your assets among your business-active children and non-business-active children. Transferring ownership shares to non-business-active children can lead to two problems. First, it can create resentment among any business-active children, because those children have worked hard to build the business, only to watch a sibling who did nothing to build the business get a share of their hard work. Second, it can make non-business-active children feel forced to do something they have no interest in doing to receive their share. In both cases, your company’s cash flow can be affected, potentially harming your ability to exit your business with financial security.

Time – Ownership transfers to children usually require owners to wait longer before receiving full sale value. This means that your finances may be exposed to general business risk for longer. If the company or economy experiences a downturn, you might need to wait longer than you had anticipated to receive the full sale price, which can affect your post-exit plans.

Another time factor that many owners overlook relates to how much time they’ll need to spend training their children or refereeing squabbles among them. If your children aren’t ready to run the business without your help, you may find yourself doing more work for longer, which can prevent you from doing other things you want or need to do to achieve your exit goals. Additionally, if you need to mediate fights among children – whether it’s related to who should do what within the business or asset allocation between business-active children and non-business-active children – you may end up spending more time cleaning up messes or, worse, having to take the reins back to prevent your children from doing permanent damage.

Values – Although many owners assume that their children will run the business similarly to how they ran it, this isn’t always the case. If a child decides to run your business differently than you, it can create discord or amplify existing friction among your family members. This can cascade into problems that affect the money you receive and the time you spend in the business.

Differing values can also create hard feelings among in-laws, who might feel that you aren’t treating their interests fairly. In the worst scenarios, in-laws can use access to grandchildren as bargaining chips to get what they think they deserve out of your ownership transfer.

Business owners often fail to identify the consequences of a poorly coordinated ownership transfer to children until it’s too late. And, even when these concerns are addressed, business owners must then focus on the questions they must answer to transition the business successfully. If you’re considering transferring your ownership to your children but aren’t sure whether you’ve addressed these potential problems, contact your team of advisors today.

Jonathan Benner is a Certified Financial Planner™ with LPL Financial in Chesterfield, Missouri. He can be reached at jonathan.benner@lpl.com.

Leave a Reply

Your email address will not be published. Required fields are marked *