Passing the business on to a relative can be relatively easily if you follow these steps.
Is selling or otherwise passing a small business to a family member a pitfall-free experience? Of course not, says Bill Worthington, an assistant professor in Baylor University's Hankamer School of Business. But that doesn’t keep it from being a positive one for most such entrepreneurs.
"There’s a whole different dynamic to consider and deal with when your successor is a family member," he explains. "Both parties know the other’s weaknesses, for example, and that can cause hesitation on the part of the incumbent or aggression on the part of the successor."
Still, as long as all involved are properly prepared—because, as Worthington says, succession is a process, not an event, and usually takes years to put into place—it can be a boon for everyone involved. One important reason, according to Worthington: Quite often the relative successor "has grown up with and has been exposed to the rhythm and language of the family business—and that’s hard to replace or replicate."
Scott Estill, J.D., a partner at Littleton, Colorado-based Estill & Long LLC, agrees that "generally this can be a very good idea," but adds that it depends on the type of business and even the people involved. For instance, for Estill to pass his law practice to his kids "would be much more difficult than [it would be to pass] a retail location to them due to the personal nature of my services.
"But if the business is appropriate and the kids are willing to take on the challenge," he adds, "there can be many benefits from a tax perspective."
Incorporate Estate Planning
As Estill explains, "The parents can get the business out of their estate through planning, whether it be annual gifting amounts—currently $14,000 per year, per person—or the use of entities such as limited partnerships for minority ownership valuation discount issues."
Such efforts, he adds, "can be combined with other estate-planning vehicles to allow a proper transfer at death and also provide security and income for the parents while they are in their retirement years."
Before small business owners come to any of those decisions, though, Estill advises that their companies be valued by an outside appraiser. "Once that is done, planning can begin."
Case in point: If the business is to be sold, "the capital gains can be estimated so the owner knows what his or her tax hit will be," Estill says.
"If there was a direct sale, the same capital gains issues would need to be analyzed," he continues. But when a family member is involved, there are other options—such as the ones mentioned earlier that revolve around getting ownership to the children in the most tax-advantageous way possible.
"Once all of the sales options are present," Estill says, "the owner should be able to see how to maximize value from a tax perspective and how the ownership could be structured to accomplish his or her goals."
Hire Professional Help
No matter what you decide to do in such a situation, or how you decide to do it, Estill recommends enlisting professional assistance early in the process, which means hiring "a business appraiser for valuation purposes, a CPA or tax attorney for tax considerations of the sale or transfer, and a business or estate planning attorney to draw up whatever documents are needed."
Worthington also suggests small business owners not go it alone in these kinds of circumstances, although he adds that in his experience "there tends to be too strong of a leaning on estate planners and attorneys and advisors. Most of them are very good at what they do, of course, but they’re not necessarily very good at being strategists for your business."
As such, his advice is to "step back and consider from a strategy standpoint if this is the wisest thing for you to do. Once you’ve decided that, you can bring in the technicians to execute your plan. But if you allow them to come in and use the latest, greatest loophole they can find to drive your strategy—well, it may not be the best thing for you, your family, or your business."