Sell or gift to the next generation?
Strategies for selling or gifting your family business to the next generation
As family business owners, we all admire the growth and successes of our companies. But deep down, we know our legacy hinges on successfully passing the torch on to our next generation. It is our duty to prepare them for the responsibility of carrying on our traditions and growing the business to new heights.
When it comes to the mechanism of transferring ownership, often we are stuck with myriad paths to follow, unsure of which is best. Should the next generation purchase their shares in the business, should ownership be gifted to them or should they earn shares through work? Should distributions be spread equally among the family members? While no plan is a one-size-fits-all solution, we can examine the pros and cons to help crystalize your thinking about how best to proceed with your family business.
All things being equal
Before we can tackle the many forms of dispersing ownership, we must first discuss equity in those distributions. Some families take the tact that any sale or gifting process must be conducted equally among their children, while others will grant company shares only to those working in the business. Another alternative is a hybrid approach in which some portion is equally divided and a separate portion is earned.
This is a personal decision involving what you think is best for your children and for your business. It is not an easy choice to make, but I highly recommend transparency in your thinking to avoid fights over different interpretations of your intentions when you are gone.
“Nobody never gave me nothing, let them buy it!”
Many business leaders take the view that if you don’t pay for something, it holds no value. To impart a greater sense of worth to the rising generation, they will work out a sale plan in which the NextGens will be paid out as if the business were being sold to an unrelated third party.
The benefits of this can be a greater commitment from the next generation— having them put “skin in the game,” as it were. One key drawback to selling shares is the tax implication for your estate. In a sale, your estate now has abundant cash that will be taxed upon your death (estate tax). There may be more tax-efficient strategies that can be found through gifting.
Giving the greatest gift of all
Alternatively, some families will gift or bequeath shares to their descendants as a way of passing the business on. There are many tactics for decreasing the value of shares that are gifted directly or through trusts. These plans can efficiently make use of your lifetime gifting exemptions and allow you to bypass significant death tax bills. On the downside, the person giving away the business may be left with too little in their estate to enjoy their retirement. Additionally, you must face concerns about instilling accountability and responsibility in the next generation of leaders.
ESOP or a Leveraged ESOP (Employee Stock Ownership Plan)
A third alternative is to transform the ownership structure to an ESOP. In a typical ESOP conversion, the company’s ownership is converted from a single family owning the business to a more collective ownership arrangement among the employees. Such a conversion can include a higher percentage of ownership being allocated to direct descendants in managerial roles but likely would result in loss of control by the family.
If structured correctly, ESOPs can avoid capital gains tax at the completion of the transaction. Additionally, you have the benefit of leaving a benefit for your loyal employees. The downside to such transactions is that they are more complicated and regulated, so hiring good advisers is key. Also, a fiduciary trustee will negotiate a “standard financial transaction” but a strategic buyer might pay much more than that, so you would not maximize your exit value via an ESOP.
Ultimately these are very personal decisions to be made. You must approach them as a loving parent, attempting to provide the best guidance for your children. You must approach them as a sage business leader, looking to provide steady leadership for your organization. Finally, you must approach them as an individual investor, looking to set yourself up for a successful retirement. The balancing act is not easy, but nothing in a family business ever is.
Chris Yount led his third-generation family business before selling the company in 2018. He is a writer and frequent contributor to Family Business magazine.
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