Business Insights
Creating Your Family Business Transition Plan

Article

Strategies, structures and tactics to make your family business transition plan a success.

If you’re the head of a family-owned business, chances are you’re thinking about the future of your business. “Who will take control of the business and manage it the way I would?”

The importance of this question cannot be overstated. In fact, Dennis Tygart, Wealth Strategist at Regions Private Wealth Management, estimates that 70% of privately held businesses will pass to new owners in the next 10 to 15 years.

The reason? Many family-owned businesses are led by baby boomers who are near—or beyond—typical retirement age. Many owners who had planned to transition their businesses years ago were stymied by the economic headwinds of the Global Financial Crisis and, more recently, the pandemic. “We had an economic crisis and then we had COVID,” Tygart says. “You have business owners who are just now getting to that point where they’re ready to think about passing the reins to someone else.”

Small business owners who would like to see their businesses continue operating have a couple of options: Sell to an outsider, such as a private equity firm or a competitor, or pass the business to family members or employees. Transferring your business to your next generation or a trusted employee can be gratifying, but it can also be more complicated than selling.

“We always talk about the good news and the bad news in business transition planning. The good news is you have lots of options,” Tygart explains. “But lots of choices can also create paralysis.” Here is how you may want to start planning your transition.

Plan Early and Communicate Your Plan

For an internal transition that’s as successful as your business has been, time is your best ally. “Realistically, if you’re at that point where you’re saying, ‘Okay, I’m going to transition within the family,’ expect a three-to-five-year process,” Tygart says.

The transition is a years-long process because of how much you’ll likely have to teach your successor. You’re putting a development plan in place for that next generation, running them through the different roles in the business, giving them a concentrated version of what you went through to build the business in the first place.

Before you kick off your plan, it’s important to confirm that your intended successor actually has their sights set on the job. It’s not uncommon for an owner to assume a child wants to succeed them in running the business—even one who is working at the business—only to be proven wrong.

Tygart recalled one client whose son worked in the family business. “When we sat down with the dad to talk about transition, he said, ‘My son is going to take over the business.’ But the son had far different plans in mind. His goal was to help his father until it was time to sell the business and then go into a different field.” Communicating your plans can help you avoid being blindsided.

Identify the Most Efficient Transition Strategies

Once you know who you’re transitioning your business to, it’s important to determine the most efficient and effective way to move forward. Most small business owners cannot afford to transition their entire business to the next generation. When that business represents the bulk of your net worth, you may need some of that wealth to help fund your retirement. If you cannot afford to transition the entire business, then one option is to gradually gift shares of the business to your successors.

Alternatively, if you want to retain control of the business while you pass it on, you can create and gift non-voting shares, which can later be converted to voting shares at your discretion. “The children, or successors, cannot sell them to anybody, and they do not get to make decisions over the business until you are ready,” Tygart says.

Business owners might even lend money to their children or employees, or owners may execute an installment sale where the purchase is spread over a number of years. Bank financing is also a common solution.

Determine the Value of Your Business

Whether you plan to transition the company internally or sell it to an external buyer, determining its value can help you decide how—and when—to proceed.

Valuations can be informal, or you can get a more comprehensive one, which you may need for tax purposes. With an internal transition, it’s important to note that the IRS carefully examines intra-family business sales. A valuation by a qualified valuation advisor helps ensure compliance with IRS rules and regulations.

“Buy-sell agreements between family members, for example, must have formal valuations because the IRS may contend that a ‘sale’ was undervalued, potentially avoiding or reducing the taxes that would otherwise be owed,” Tygart says.

It’s also a good idea to have your business valued long before you sell or pass it on. A valuation provides insight into the question, “What drives value in your business?” And whatever drives value in your business will drive profits today and a potential sale price tomorrow.

Plan for Your Own Life and Legacy

Whether you sell your company outright or maintain a revenue stream from it during retirement, your plan needs to provide you with enough income to support your desired lifestyle and all that it includes, such as travel and philanthropy.

A common challenge for many owner-operators is that they’ve never managed a transaction of this magnitude. How you structure the sale, the timing of the transaction and the type of company you’re selling will affect the taxes you will owe. With sufficient time to prepare, your team of professional advisors can help you find the most tax-efficient approach.

And with so many moving parts, it’s no wonder that transition professionals recommend years of planning. That can seem like a tall order while you’re still fully engaged in running your company, but your Regions team can assemble a team of professionals—including legal, tax and transition specialists as well as financial planning professionals—to help ensure that the time and passion you invested in your business pays off in a future as bright as the past.