Family Business Succession Planning: Questions To Ask

Anyone who owns a family business is intimately familiar with the blood, sweat, and tears associated with building and then keeping the business viable. It’s very hard work.

Nevertheless, it is not unusual for the business owner to postpone consideration of various issues involved in transferring the business to the next generation, including determining the value of the business.

This lack of preparation is often one of the reasons the risk of failure increases as family businesses are transferred to succeeding generations and a business exit startegy is not formulated.

As an analogy, think of selling a business in much the same way as selling your home. The time to address issues is not on the cusp of a sale, as this reduces bargaining power. Rather, prepare the home before you list it for sale. Similarly, you must prepare with family business succession planning if it is to occur successfully. In anticipation of this most important event, here are a number of points to ponder.

What is the value of the business?

Determining the value of the business is essential to an effective exit plan, even if that plan involves giving the business away at death. Unless an owner has a realistic understanding of value, it is impossible to understand the tax implications of the transfer.

Just as important, if the business will be transferred to certain family members, excluding others, knowing the value of the business is imperative if you are attempting to treat family members fairly. That’s why utilizing the services of a professional appraiser is essential and need not be cost prohibitive.
To whom should the business be transferred?

While the fair minded business owner would certainly like to treat each of his or her heirs equally, unless all of the heirs work in the business, it’s utopic to think that transferring a business in this fashion. Generally, this situation can breed resentment, especially if certain heirs work for the business and draw a salary, while the rest of the heirs contributed no effort to grow the business and/or receive little if any benefit from their ownership.

If the entrepreneur does not wish to leave the family business equally to his or her heirs, then are there other assets that can be used effectively to make non-business gifts to other heirs? But if the business’s value is substantially larger than the balance of the individual’s other assets, this type of distribution may not be possible, particularly following the payment of death taxes.
Have you Considered the Impact of the Family Business State on Inheritance and/or Estate Taxes?

In this vein, how much federal estate tax and potentially state inheritance and/or estate tax will be payable at the death of the business owner?

In 2022, only those estates in excess of $12.06 million will be subject to federal estate tax. For most business owners, having an estate at death worth more than the current taxable amount, especially if married and able to double this exemption amount to $24.12 million, would be a great problem to have!

For those who do, careful consideration should be given to determine if there will be other available funds to pay those taxes? And if so, will those funds be depleted to the point where parity no longer exists between those intended to receive business versus non-business assets?

Or, if an estate plan is structured so that the estate taxes attributable to the business interests are to be paid by the recipients of those interests, will those individuals have their own money to pay the taxes?

If a business is the entrepreneur’s largest asset in her estate, taking action during his or her lifetime may be the only way to ensure success in transferring the business to the next generation, including minimizing what can be an unmanageable estate tax at death.

Such action may include a thoughtful lifetime gifting program, or a partial sale of stock to those individuals. Some form of a valuation discount may apply to the sale of some stock, particularly a minority interest, may be subject to some form of valuation discount, thereby enabling the transfer of a greater percentage of the company to the intended recipients. A sale of stock may also increase the pool of funds that ultimately will be utilized to pay estate taxes, or make gifts of non-business interests.