BUSINESS TRANSITION PLANNING | SMALL STEPS FOR LESS STRESS
MIRANDA K. CARMONA
Partner with Goodell, Stratton, Edmonds & Palmer, L.L.P.
Transferring your family business to the next generation of leaders can be a complicated process, both logistically and emotionally. It requires considering several factors including which assets are being transferred, who will be giving and receiving those assets, when the transition will take place, how the transition will take place, and your own family’s dynamics. All these factors can be overwhelming if you think of the process as one transaction, leading to additional stress and possibly inaction when planning your business transition.
Like most things, effective business transition planning does not have to be done all in one step, nor should it be. Breaking it into smaller steps clarifies your objectives, prepares you emotionally, and directs you in your decision making.
Secure Basic Estate Planning Documents
The first step is to secure basic estate planning documents. A business owner is almost always better served by using a revocable trust and a pour-over will, rather than just a last will and testament, to transfer the business.
When properly funded, a trust can avoid probate and its setbacks, including court oversight of the transfer and public access to personal information. While probate is not always as bad as the horror stories you may have heard and can even occasionally provide
a good forum for oversight, in a business, it is almost never a good idea to involve additional complication to the day-to-day decision making. Also, a revocable trust can provide a structure to own the interests of your business until you are ready to relinquish some control or implement some of the more consequential aspects of your transition plan.
You should also have a durable power of attorney for business decisions and a health care directive as part of your plan. These documents appoint someone to act on your behalf to make business and health care decisions if you are not able to. If you do not have these basic documents, a court may appoint a guardian or conservator who will make decisions on your behalf. This causes unnecessary delay, expense, and frustration when trying to make the decisions necessary to continue running your business.
Recapitalize Your Business to Create Voting and Nonvoting Interests
Next, you should ensure you have established a proper business structure. If you are operating your business as a sole proprietorship or general partnership, you should create a separate legal entity, such as a limited liability company, limited liability partnership, or corporation, to operate your business. Not only can the legal entity provide liability and creditor protection for your personal assets, but it can also provide a way to divide the business into separate shares to be transferred to your family.
If you have already established a separate business entity, you should consider recapitalizing your business into voting and nonvoting interests. Because your trust can keep all the interests, you do not have to immediately decide who will ultimately own the separate interests. Once the time comes when you are ready to make those ownership decisions and transfer the interests to the next generation, having the shares divided into voting and nonvoting interests will make the process easier, more efficient, and more flexible. For instance, you can transfer the nonvoting interests to your children equally so each child shares in the value of the business but is not saddled with the day-to-day business decisions. The individuals operating the business, which could include family members or nonfamily managers, could receive the voting shares. Additionally, if you want to include your family in the business ownership structure on a more gradual basis, gifting nonvoting interests incrementally allows you to leverage the tax benefits of annual lifetime gifts and a more gradual transition, while still retaining control of the voting interests.
Consider Life Insurance
Another small step you can take is to consider obtaining life insurance. Liquidity is often an issue in estates where most of the assets are small business holdings. Life insurance can provide a lot of flexibility to equalize shares among the family members who will be involved in the business and those who cannot or do not want to be involved.
It can be useful for purchasing ownership interests from family members that may want to leave the business, or from outsiders that the new leadership no longer wants involved with the business. It is also useful to have cash available to pay any estate or income taxes that may become due. If you have set up your basic documents, you can initially make your trust the beneficiary of the life insurance. This defers the need to name individuals as beneficiaries if you have not yet clearly defined some of the details of how the policy will be used.
Estate and business planning is an ongoing process, not a one-time transaction. Just because you are not ready to make the big decisions regarding the transfer of your business does not mean you have to wait to take any action.
By taking some of these smaller steps now, your transition plan will be more easily implemented in the future, and more adaptable to the ever-changing economic, tax, and business environment.
