In a recent survey of BEI Members, nearly 25 percent of the Exit Plans they designed were to transfer businesses to an owner’s children. Given that owners can sell to third parties, create an Employee Stock Ownership Plan (ESOP), sell to partners or key employees, or exit without giving up ownership, one quarter is a healthy percentage. In this article, we look at the advantages of this exit path.
Let’s begin with one of an owner’s foundational goals, financial security.
You can structure the ownership transfer to ensure that the parent-owner receives the amount of income they need or want during and after their exit—even if the business value does not justify that sum of money. You can also design the transfer so that the owner retains control of the business during the buyout period and until the owner receives all of the money they want or need.
The Time Factor
It may take longer for an owner to phase out of ownership in a transfer to children than through a sale to a third party or a sale to an ESOP. That longer transition time has several benefits including:
- The owner has options if something unexpected happens, such as the owner’s sudden disability or the receipt of an inheritance from a long-lost family member.
- The transfer of ownership over several years also provides time for the incoming children-owners to be thoroughly trained and prove their capabilities to run and grow the business.
The Time Margin
Owners have time, while receiving income and maintaining control, to slow down and develop other interests and pursuits outside of the business. This means owners have the time to prepare themselves, the children, and their businesses for life after the sale. We call this “time margin.” With children in management, many owners feel more comfortable reducing the amount of time they spend in their companies. This comfort is due to an owner’s trust of family members that often does not exist with non-family companies.
Using a strategy unique to family transfers, we can minimize (and even avoid) income taxes on transfers of ownership to family members.
The capacity to achieve an owner’s “softer” goals is often the deciding factor for owners when selecting a particular exit path. Transferring a business to children meets several of these goals including:
- Legacy - The joy and satisfaction owners gain from working with their children can continue throughout and after the ownership transfer.
- Benefits to Children - Keeping the business in the family may provide children greater employment and financial opportunities than available elsewhere.
- Family Identity - The business continues as the family’s focal point and acts as the “glue” that helps the family stick together.
- Fulfills Children’s Expectations - For many families, the child(ren) has grown up in the business and wants to stay in it. Acquiring ownership fulfills this expectation.
- Family Pride - The owner continues to reap considerable (and justifiable) satisfaction from traditions and values that benefit family, employees, customers, and community.
- Community - The children are unlikely to move the company out of the owner’s (and their) community.
Owners and their spouses can select the child or children to be the successive owner(s) of the business.
Benefits to Advisors of Helping Owners Transfer Their Businesses to Children
There are three key benefits to advisors who are able to help owners who wish to transfer their businesses to their children.
- There is substantial ongoing core professional work for business advisors in implementing a successful ownership transfer from owner to their children.
- Ownership is typically transferred incrementally over several years during which you can provide ongoing representation.
- Perhaps most importantly, your representation can make a real difference in the lives of your owner clients and their families.
Properly designed and implemented transfers to children are income-tax efficient and allow parents to remain in control of the business until their goals and aspirations for themselves, children, and perhaps the community, are achieved. If you would like information about the variety of designs and tools that Exit Planners employ in successfully transferring family businesses, please contact a BEI representative.
Tune in next week to learn about the disadvantages of transferring a business to the owner's children.