Note to production: Harvey Goldstein was previously published in the Jan. 11, 1999 edition
Harvey A. Goldstein
For years, experts have been touting the importance of succession plans for keeping a business in the family after the owner’s death. But only about 25 percent of family businesses have a written plan.
Why do so many owners neglect such planning? Over the years, I have heard the following excuses:
“I don’t want to give up control of my family business.”
“I have more than one child. How do I fairly choose a successor?”
“I’m too busy to think about it.”
Admittedly, succession planning involves difficult choices. It also requires time. But several months of careful planning will translate into a family business with a good chance of surviving into the next generation, as well as a family whose members have a clear idea of their future roles.
The first step in creating a succession plan for your business is to decide what you want for its future. The following questions will help you make decisions regarding your plan:
? Do you want to keep the business in the family or allow it to be sold?
? Which family members have the interest and capability to participate in the business?
? How will you provide for children or other family members who will participate?
? If you plan to keep the business in the family, who will manage it?
? Will you use your business to fund your retirement?
? If you decide to keep the business in the family, how will you shield it from the potentially crippling effects of estate taxes?
Once you have answered these basic questions, you are ready to frame a succession plan.
One of the most difficult issues is how to divide the business among your heirs. Quite often, the children of family business owners will belong to two distinct tribes: active and inactive. The problem with this situation is how to equally divide your business among your heirs while recognizing the efforts of the children working in your business.
One area of potential conflict is control of the company. If inactive children hold voting stock, they may hamper important decisions and frustrate the children actively working in the company.
Solutions to this problem can be worked out in the succession plan, which can be tailored to the needs and desires of the individual owner. Also, the structure of your business whether a limited liability company (LLC), S corporation or partnership will impact the plan.
As an example, there are several things we have found to be successful for S corporations. Issue new stock and transfer it as compensation to family members active in the business. Eventually, they will hold substantial interest in the company, and if your stock is equally divided among your children, the active members will hold a controlling interest.
You can also issue non-voting stock that gives your inactive heirs economic interest in the company without control.
One of the most difficult times any family business must face is when the death of an owner results in a hefty estate tax bill. Many family businesses are decimated by this tax bill and simply close up or sell off assets at fire-sale prices to pay it off.
However, there are several ways to reduce your estate tax bill and keep you business assets out of the hands of the government.
By using a limited partnership, you can transfer your assets to your heirs while retaining control. If your business is worth more than your lifetime estate and gift exemption of $600,000 each for you and your spouse, you can use your annual gift tax exclusions to transfer wealth into the partnership over a period of time.
For example, if you and your spouse give $20,000 a year in stock to one child, at the end of 10 years you will have shifted $200,000 of your company’s present value to the next generation. Multiply that amount by the number of children, grandchildren and their spouses, add it up to $1.2 million in lifetime exemptions, and you may be able to remove the bulk of your business from your estate. However, keep in mind that this requires long-term planning.
If you and your spouse are transferring minority interests in your company, you may be able to gift stock that is appraised at more than $20,000, because the Internal Revenue Service allows discounts for minority interests as well as for lack of marketability. The theory is that the owner may be stuck for many years with an asset over which he or she exercises little or no control.
No matter how well you plan, your estate may still owe some taxes. A life insurance policy can provide your heirs with the money to pay your remaining estate taxes without selling off the business assets. For this measure to work best, the policy must be held in a life insurance trust that will keep the proceeds out of your estate.
Once you have made your decisions concerning the future of your business, put your plan in writing. We also recommend that you communicate your wishes to everyone involved. And finally, periodically review your plan and make updates when necessary.
Harvey A. Goldstein is managing partner at Singer Lewak Greenbaum & Goldstein LLP in Westwood. He can be reached at firstname.lastname@example.org.
Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.