To the owners of family businesses, estate planning can sometimes be an after-thought. Owners are often so involved in building their business and managing its daily operations that they do not have time to devote to the planning that will become important when the owner is ready to hand over management control and ownership to successors. It is often the case with successful family businesses that there has been little or no thought given to the transition of management and ownership, with the result being there is no succession plan in place. Further, available strategies to transfer the ownership of the business to younger generations of the family in a tax-effective manner may not have been utilized.
When a family business is one of the assets, or perhaps the primary asset, a well thought out strategic and financial plan for the business and an estate plan for the family are critically important. The following is a brief and by no means exhaustive outline of some points to consider.
A good place to start is with strategic planning for the business. Are other family members employed in the business, or likely to be employed in the future? Will those family members one day have the desire and temperament to manage the business? If so, map out a plan for increased responsibilities and changing roles over time.
Is it more likely that when current management retires, the business will be sold? In that case, identify the people and resources who can help with an eventual sale. Does the business have non-family members involved in management or as board members? Would having an objective third party on the board provide a perspective that would benefit the business?
Obtaining an appraisal of the business by a CPA experienced in business appraisals or other business valuation expert is an important step. Consideration should also be given to key man insurance, which could help pay down debt and provide capital during a management transition.
Two classes of stock, one with voting control and one without, can help maintain control by the business owner while allowing transfer of equity interests to other family members (usually younger generations of the family), allowing them to participate in any increase in value. The shareholders should enter into a shareholders’ agreement that contains restrictions on transfers and sets forth a plan for the purchase of shares if a shareholder dies or wishes to sell shares. Life insurance may be needed in order to fund the purchase price.
There are estate planning strategies that work well to transfer future appreciation in a growing business. For example, gifts of restricted stock to family members or trusts for their benefit would qualify for a valuation discount under present law. In addition, certain strategies using irrevocable trusts such as Grantor Retained Annuity Trusts (GRATs) and Intentionally Defective Grantor Trusts (IDGTs) can transfer stock at little or no transfer tax cost to the donor.
When a family business is the primary asset, a business owner may have liquidity needs in order to pay death taxes and other expenses. Life insurance is usually the solution in such situations. Depending upon the size of the estate and the tax law at the time, an irrevocable life insurance trust (ILIT) may be employed to prevent inclusion of the insurance proceeds in the owner’s taxable estate.