“Divide your estate fairly, not necessarily equally.”
A recent episode of “The Profit” reminded me of how complex it is to run a family business and plan for passing the baton to the next generation. This is a perfect niche financial advisors can focus on and create value for their clients.
According to the Small Business Administration, family businesses are the backbone of society accounting for 90% of all business enterprise in North America. However, only 30% will be passed to the next generation and by the third generation only 12% of family businesses are typically viable. There are multiple examples of family business that didn’t plan well for the future. Examples that come to mind in my own town include Holiday World in Southern Indiana, The Indianapolis Motor Speedway, and Marsh Supermarkets.
Reasons for this include:
Whatever the reason, advisors can help clients avoid these pitfalls by taking some simple planning steps. These steps can be integrated into your 12-4-2 client meetings.
You can help your clients follow these seven steps to create proactive succession plans. A well thought-out plan will provide both financial and emotional independence for the retiring owner and position the business for continued success and growth for future generations.
Step One: Help clients create their exit objectives. One of my friends wanted to semi-retire at 63 while still receiving a stipend for participating in some decision-making for the next 10 years. Another one wanted to sell and put the money in a trust fund for successive generations. A third wanted to gradually give control to his son but wanted to give his other two children an equal inheritance. Goals and objectives that can be identified include: determining the importance of continued family involvement in leadership and ownership of the company, identifying and retaining a team of professional advisors, developing a collective vision and reviewing the reasonableness of the current succession plan.
Questions to ask: Do you have a tax-planning attorney in place? Have you communicated your wishes to your family members? What happens when a family member dies or gets divorced?
Step Two: Establish a decision-making process. This would include identifying and establishing governance process for involving family members in decision making, establishing a method for dispute resolution, documenting the succession plan in writing and communicating succession plan to the family members
Questions to ask: Do all parties involved agree to your process? Have you established a mediator in case of a dispute? Have you communicated your succession plan in writing to all parties
Step Three: Determining Value. In one of my friend’s company the value of the business was a large part of his assets. In order to meet his retirement needs he needed to convert those assets to cash. The amount of cash needed – net of taxes – to meet your exit objectives will determine the course of action. A lot of small business owners use ‘property’ for both business and personal needs. Owners need to establish if the suite tickets to an NFL team, a lake cottage, boat or car are property of the business or the owner and take the necessary legal steps to make that clear.
Questions to ask: What is the market value of your company? Is there a market for selling it if you need the cash? How much do you need to meet your retirement goals? Have you determined personal property versus company property? A third party business evaluation is often needed.
Step Four: Establish the succession plan. Identify successors (both key employees and owners); identify active and non-active roles for all family members. Always have a back up plan. If the “heir apparent” becomes available who would be next in line?
Questions to ask: Do you issue stock for nonworking owners? Do you have a clear-cut buy-out agreement in place? What role do spouses play? What happens when a divorced/widowed spouse has stock?
Step Five: Create a business and owner estate plan. Recommend a tax attorney that can help your client address taxation implications upon sale or transfer of ownership, death or divorce, minimize taxes and avoid transfer of stock to remaining owners or spouse and create a buy/sell agreement.
Questions to ask: Do you enthusiastically endorse your tax/estate-planning attorney or can I recommend one to you? How often do you review your business and estate plan? (We recommend annually.)
Step Six: Sale to third party or transfer to a family member or employee. What makes the most sense for your client’s company? Most businesses are not sold to an outsider for the amount the owner feels it is worth and some businesses are more marketable than others. Businesses need to be prepared for the marketplace, taking into consideration physical and intellectual property, patent protection (if appropriate), tax ramifications and transferability of key employees. If a business is transferred to an ‘insider’ key considerations include capital transfer, risk and experience of the family member or employee. If the business is to be purchased, look at the financing options including financing from an external party or self-financed from the retiring owners on a deferred payout basis.
Questions to ask: Does my employee or family member have the cash necessary to buy the business? Is there a third party interested? Can a larger competitor purchase the business? What do you need to do to get your staff on board with these changes? Do I want to have an outright sale, gift/bequest or combination of these?
Step Seven: Preserve the legacy of the owner’s estate. Selling a business may be the single largest financial transaction that a business owner makes. Advisors can help their clients integrate philanthropy into their estate planning. A great example of preserving a legacy is the story of the founder of American Century Investments, James Stowers, Jr. Mr. Stowers, who passed away earlier this year, co-founded the Stowers Institute for Medical Research. Their two billion dollar endowment for the institute insures the continuation of valuable cancer research.
Questions to ask: What are your feelings about estate taxes? Where would you like your assets to go? Is there a charitable foundation you would like to contribute to or do you want to establish your own?
A warning…
Jim had established a model Ford dealership in his small community. It had provided well for his family and employees over many years. It was his life and nearly all his savings. When he planned to retire, he sold the business to the manager of the dealership who had no cash to buy it. Rather than finance the purchase, Jim carried the debt, requiring monthly and yearly cash payments.
In three years the dealership was bankrupt. Jim lost a lifetime of equity and savings and was too old to start over again. You don’t want that to happen to your clients.
…and final thought:
Your clients need help evaluating their options and assistance in finding resources for the sale of a business. By being informed, you become a true trusted advisor.
If your niche is business owners, you must be informed about the sale of a business and resources in your state and community. That is Supernova Service.