The Family Business, Part 3: Give or Sell?

I've been blogging in the past few weeks about the "family business"--i.e., that small business set up by an entrepeneur, and nourished to fruition--and issues that any successful small business owner should consider when getting closer to retirement age.

First, I discussed the issue of whether the family members had the desire or even the ability to carry on the family business, because in my anecdotal experience, fewer than half of entrepeneurs have families who are both willing and able to carry on the family business.

But for this week, let's assume your family falls into that category. If a member of you family has both the desire--and the ability--to keep the family business running, what you should consider next? Based upon my experience with family businesses, I would suggest that you next consider whether you should sell your business to your family, or whether you should give your business to your family.

The average non-entrepeneur I'd hazard would be be a bit aghast at the idea of selling his business to his family. The average non-entrepeneur believes that his or her job should be to share his wealth with his children, to the extent possible. However, entrepeneurs--many of whom came by success with some difficulty--are more open to the idea. There are many non-legal reasons why perhaps you should consider the issue of sale versus gift (i.e., anything worked for is much sweeter, in an entrepeneur's mind), but I'm going to focus on legal and tax implications for considering this question. As always, there is no generally right or wrong answer--the issue needs to be carefully considered, with the help of both tax and legal counsel. Here are just three things to think about when considering this issue.

1. ESTATE PLANNING. One thing to consider is the tax consequences of your conveyance to your children (both income and estate). Chances are, the actual "book" value of your company (i.e. the value of its hard assets) is much less than you'd actually accept for it if you sold it on the open market. Perhaps, if you own a golf course, your land is worth $1 million, and your equipment is worth another $1 million. However, if your golf course is wildly successful, you might not be willing to sell it for less than $6 million (this value added to the hard value is what is commonly referred to as "good will"). Sometimes, tax lawyers or accountants will advise a sale of the company to children in order to reduce estate taxes.

Using the above example, even if you aren't willing to part with your golf course for less than $6 million, suppose your tax advisor tells you that--since you've never received an offer for your company and it has a book value of $2 million--you could legitimately sell it for $2 million to your children. You have effectively--and legally--gifted $4 million to your children without having to pay estate taxes.

Again using the above example, had you gifted your children the golf course with a book value of $2 million, that would not, at this time, create an estate tax consequence, but if you died leaving them much more property, you might very well create an estate tax burden for them (the subject of estate taxes is too lengthy and complicated to go into at depth; if you have any questions, please contact me and I will refer you to an excellent tax attorney).

Therefore, arms-length sales are sometimes an effective means by which to reduce your estate tax burden before you die.

2. REDUCING INCOME TAXES. Sometimes, a sale versus a gift can reduce the income taxes your family may pay on its property in the long run. This is especially important if you are considering, in the short term, a sale of the business to an outside investor. Using the golf course example, again, let's say that, when all the equipment and land were purchased, their book value was $300,000. If you were to sell the business right now for $6 million, you would pay taxes on your gain (Sales price of $6 million, minus original basis of $300,000 = taxes on $5.7 million). If, however, you could in good faith sell your family business to your family for its book value ($2 million, in my example), your family would pay taxes on the gain of $6 million minus $2 million, which would reduce its taxable basis. (Understand that I'm using simplistic examples: a tax advisor may tell you to hold your business until you die so that your children could get a "stepped up basis"--in this case, $6 million; so please understand there is no one formula that fits all).

3. SELLING YOUR BUSINESS TO FAMILY CAN PROVIDE YOU INCOME. Let's say that you family is willing and able to run you business, and your tax advisor believes that an arms-length book-value transaction is the best idea for your business. There's another good reason to sell your business versus giving it away: it can provide a steady stream of income. First, an assumption: almost no sale of family businesses to another family member involves an actual cash purchase. Instead, they typically involve selller financing. In addition to providing you tax savings, selling to your family can provide you a steady stream of income in the form of seller financing payments back to you on a promissory note. This is often important anyway, but if I am representing the spouse of a deceased entrepeneur, often this is even more important. Selling to the children, and owner-financing the sale, can provide to the seller a steady stream of income during the seller's golden years, while at the same time giving his or her children tax benefits and a leg up in this world.

If you have any questions, please call my office and set up an appointment at 704-735-0483.

Passing on the Family Business

Passing along a family business may seem like a pretty simple process. The entrepeneur builds a successful business, makes a solid living, then passes it along to his or her children. Easy, right? Unfortunately, those entrepeneurs fortunate enough to have created a successful business have found, when the time actually comes for them to pass the torch, that things aren't so easy. If you own a successful business, here are some issues that may come your way. In future blogs, I'll go through these different issues and describe how they can be overcome. But for now, give them some thought well before the time comes for you to pass down your business.


1. Do your children want the business? The first, and most basic question to ask yourself is, do your children really want the business? Do they have a desire to carry on the family business; do they have the same passion (and ability) to do what you are doing; and are they currently involved in your business? Or, have your children enjoyed the benefits of your business (e.g., annual gifts of cash, a company job at an inflated rate, a higher standard of living than their career would otherwise allow), but don't seem to have an interest in doing what you did to provide those benefits?

If your children are already adults (and you're considering retiring), chances are you probably already know this answer. But knowing the answer, and making future plans for yourself and your family, are two different things. If your family is not interested in joining, working at, or perpetuating your successful family business, then it's time to start thinking about your own future. You may want to consider selling the business while you are still healthy, and while the business has goodwill. Because if you have no one to succeed you, and you hold on to your business until you die, your business' value will wither quickly while your children try to orchestrate a quick liquidation.

If, on the other hand, your children are interested in taking over and continuing your business, you need to consider how best to accomplish such a handover. The way you accomplish this may have profound consequences, affecting your own standard of living during retirement; the net worth of your children; and estate taxes that may be suffered by your estate after you die.


2. Give or sell the business? Assuming one or more of your children do want to own the business, how should you convey it to them? Should it be a gift? Or should you sell it to them? While many people, at first blush, might be aghast at the idea of making their children pay them money, the decision on how to handle this shouldn't be made without the collective advice of tax and legal professionals.


3. Should you keep any control? When you convey the business to your children, should you walk away? Or should you retain the right to make business decisions even after you no longer own it? The decision you make should depend on the particular circumstances of the family members who will be taking over your business.



4. If you sell the business, should you take cash or owner finance? A cash payout will provide you hard, liquid assets that will allow you to live out your retirement goals. Owner financing, however, also has its own benefits--both for you, and the family members buying from you.

If you live in North Carolina, and have questions about a family business, feel free to contact my office to set up an appointment:

wldeaton@bellsouth.net
704-735-0483.