Last month, life delivered Michael a wake-up call in the form of a mild heart attack.

A widower of 58 with a grown family, Michael is a successful entrepreneur with a thriving family business.

And like the vast majority of family business owners, he hopes his business will remain in the family as a source of financial security and employment for generations to come.

Regrettably, the odds are not in his favor.

The Crisis in Family Business Succession
The statistics for family business succession are dismal: Less than a third of all family businesses successfully transition from first generation to second generation — and less than a third of those eventually transition to the third generation.

The primary causes? Lack of advance planning for management succession and ownership succession, along with the estate planning required to support a transition.

Only a quarter of family businesses in the U.S. have given serious thought to succession planning according to the Laird Norton Tyee Northwest Family Business Survey 2008, and a surprising half of all senior-generation family business owners have no written estate plan.

If you’re the owner of a family business, you can enhance the odds that your business will remain in the family with a little advance planning for the following:

  management transition

  ownership transition

  estate taxes and other liquidity issues

Planning for a Transition in Management
Michael has long prepared for the future management of his family business. Both of his sons worked in the business while growing up and, although his oldest chose a career in law, Michael’s younger son inherited a love of the business and has the education and acumen to succeed his father as CEO.

Not all businesses have an obvious management successor — either due to lack of interest or ability on the part of family members, family discord, or because the intended successor is too young or lacks training or experience.

For some, sale of the business to employees or other third parties is a viable option. An increasing number of family businesses have turned to nonfamily executives to run the company on an interim or long-term basis, allowing the family to retain majority ownership.

Regardless of approach, planning for a transition in management requires time, an honest appraisal of goals and abilities, and open communication among all interested parties — often with the assistance of a trusted advisor.

Planning for a Transition in Ownership
Management succession isn’t the only hurdle for successfully transitioning a family business. Transitioning ownership and the estate planning it requires are major hurdles for many families. It’s something that Michael, at a relatively young 58, hasn’t adequately planned for.

Planning a transition in ownership includes an analysis of the most appropriate ownership structure after the transition. Typical considerations also include the following:

  Who can own shares?

  Should there be voting and non-voting shares?

  What restrictions, if any, will be placed on sale of the shares?

  Is there a buy/sell agreement?

  Will ownership be split equally among children or grandchildren?

  Will children who work in the business be treated the same as children who do not?

  How will spouses (current or former) and the children of blended families be treated?

Estate Planning for Family Business Succession
For many family business owners, including Michael, the business itself is the family’s major asset, as the earnings have been reinvested in the business. As a result, liquidity can be an important issue.

To implement the succession plan and achieve the underlying personal, financial and business goals, owners like Michael need a well-thought-out estate plan developed and maintained with the assistance of a trusted advisor.

Among the many estate planning considerations for a business transition are the following:

  What is the overall strategy to minimize the impact of income, gift and estate taxes?

  Where will the liquidity to pay income, gift and estate taxes come from? Is life insurance a viable option?

  What will provide liquidity, if needed, to buy out the business interest(s) inherited by a widow, widower or other beneficiary?

  Will a revenue stream for family members not employed in the business be necessary, and what will be the source of this cash?

Unless the entire estate — including the family business — passes to the spouse or to charity upon the death of the owner, the estate will be subject to estate tax based on the market value at the time of death. (2010 is an exception: Barring Congressional action there is no federal estate tax, although Washington State’s estate tax still applies to estates over $2 million.)

To minimize the impact of taxes, estate plans often rely on a technique referred to as an estate freeze that facilitates planning by locking in the value of certain assets at a point in time and deferring taxes on appreciation to future generations.

There are many approaches to implementing a total or partial estate freeze, including gifting, installment sales and the use of trusts. For most business owners with taxable estates, the earlier the freeze is implemented the greater the potential tax benefit.

Ultimately, there is no one best approach to estate planning for a family business owner, although life insurance and estate freezes are common elements.

Instead, the process is unique to each business and owner, taking into consideration the owner’s family situation; the size and characteristics of the business; and the family’s personal, financial, and business goals. Advance planning is essential.


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