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Estate Planning: Passing On the Family Business

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Estate Planning: Passing On the Family Business

Business Succession
A successful family business is a cornerstone of many families' wealth. But passing the business along to the next generation takes substantial planning and preparation.

A recent Pricewaterhouse Coopers report found that while just over half of the family-owned business executives wanted to pass on their business to children, just 27% of these companies had a robust, actionable, succession plan in place.

Here are some important things to keep in mind:

Choose the appropriate entity.

You can't pass on an existing family business as a sole proprietorship or general partnership. You can pass on the assets, but not the business itself. Also, you can't pass S-corporation shares to a non-resident alien.

Involve family in business succession discussions.

It's important to get family input years ahead of time, and involve them when discussing succession planning. Sometimes family members may not want to go into the family business. The sooner you know, the sooner you can make other succession arrangements.

Have a will and buy-sell agreement in place.

All shareholders should have a will precisely defining what happens to their share of the business upon their death. Without a will, a deceased owner's interest would automatically go to his or her spouse, children or other next of kin according to state default intestate laws.

But the heirs may not want to be involved in the business. A will and a buy-sell ensure that control of the company will remain with the people committed to the business.

A life insurance policy on each shareholder, with the company or with the other owners as beneficiaries, may be a good way to ensure that there will be enough cash available to buy out surviving spouses or other heirs of any deceased shareholder.

Consider passing on ownership, but not management.

Sometimes adult children of entrepreneurs may not be in a position to manage the day-to-day business. But they could be excellent as directors and shareholders. In this case, work on recruiting and developing outside management to run the business as employees.

If this isn't practical, it may be best to explore selling the business outright.

Make equitable arrangements for other children.

If you have multiple children, chances are at least one of them will not want to take over the family business, or will be unable to do so for any number of reasons. Possible solutions:
  • Start amassing assets outside of the business as soon as possible.
  • Own life insurance sufficient to equalize the inheritance.
  • Divide the businesses ownership into voting and non-voting chairs, in order to give the most capable or involved child operational control without disinheriting the others.

Provide for the founder rent income security.

The business should provide an income for the founder and their spouses for as long as they live. Possible techniques include:

Purchase. The founder's children will pay the founder outright in cash for his or her shares, either in a lump sum or installments.

Preferred stock. Convert the founders interest from common stock to preferred stock. The founder doesn't get to vote shares anymore, and no longer controls the company. But preferred stock dividends get paid first.

Nobody can take any dividends out of the business unless the preferred stock dividend is paid. Upon the founders death, a preferred stock goes to the surviving spouse, then gets passed on according to the last will and testament.

Don't try to wing this process. Family business succession planning is a long process, and you will need the help of attorneys, tax professionals, insurance professionals and business valuation experts along the way.