Generational transfers represent a common attribute of family-owned business, which other types of businesses typically do not need to worry about. Despite the benefit of having a natural successor, family business transfers need to be planned appropriately to factor in leadership succession, estate planning, and the actual ownership transfer.
The combination of these factors contributes to why most family-owned businesses do not make it past the second generation. In fact, studies have shown that only a third of family businesses have successfully transferred to the second generation, and only 13 percent make it to the third generation.
This blog will briefly address some commonly-asked questions we have received from family business owners. These common questions can often be stumbling blocks which hinder the beginning of the transfer process.
How much is a fair price?
In many cases, owners do not know where to begin, because they may not have a sense of the true value of the business. The first step in any business transition is to understand the value of the business. This is critical to understand the potential value transfer, set the stage for determining an estate plan, and help determine the options for financing a transaction. A formal valuation is generally not necessary to estimate the process; however, obtaining the assistance of a professional is highly recommended.
How will the transaction be financed?
The methods available to finance a family business transition are numerous. We’ve seen family businesses transitioned with cash, debt, and gifts. Depending on the business and level of profits, banks may be willing to lend to the business, which can provide some down payment money to the exiting owner. In many cases, a seller note is involved, where the owner has their equity redeemed by the business in exchange for a note receivable from the company. Over the next several years, the excess profits of the business will be utilized by the new or remaining owners to pay off the exited owner.
Are there ways to make the transaction tax efficient?
Simply put, yes. There are plenty of ways to reduce the tax impact related to a family business transfer. Understanding the owner’s financial picture is essential in determining the proper path. For example, an owner who does not need to derive a lot of value from a business exit may look to use techniques such as gifting to save significant estate taxes. On the other hand, owners who need to derive cash flow from the business for retirement needs may look to alternative structures such as a deferred compensation arrangement.
When should I start planning?
Okay, maybe this is not a frequently asked question, but it would behoove us to remind owners that is it is never too soon to get started. Some of the techniques mentioned above could take years to implement properly and effectively in order to ensure a smooth, tax efficient, and fair transition.
If you would like to discuss your family business transfer, please contact your Kreischer Miller relationship professional and we will be happy to provide a free consultation.
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