We’re pleased to provide you with insights like these from Boston Private. Boston Private is now an SVB company. Together we’re well positioned to offer you the service, understanding, guidance and solutions to help you discover opportunities and build wealth – now and in the future.
Succession planning options for family-owned companies
You've spent years building your company — perhaps half a lifetime. Now you're thinking about your legacy and your family's well-being, as well as the future of the business. Leaders who fail to designate successors and who don't establish a clear strategy for how transferring a business will occur jeopardize the companies they've built from the ground up.
What matters most
Before strategizing a business transfer, you need to define your priorities. Is your primary goal to keep the company within the family? Maintain your legacy? Minimizing the tax burden in the sale? The answer will determine which option you choose.
Ideally, you'll select your successor well before it's time to sell so you can ensure that this person wants to take over and is prepared for the job. Succession plans involve lengthy and potentially emotional conversations about legacy, values and where the company should go once you've stepped down.
Should you decide to transfer the business to a family member, you'll want to do so strategically. Gifts above $14,000 are subject to taxes, so you might opt to move your shares to the recipient over the course of several years. Doing so removes the risk of a transfer tax, and it also reduces the amount of your taxable estate.
If you plan to sell the business before your death, perhaps as part of a retirement strategy, you may be liable for capital gains penalties, depending how you structure the transfer. A wealth advisor and tax attorney will be able to help you navigate the options and choose which best suits your retirement plans as well as your goals for the business.
Here are some common options for transferring a business to family members:
This choice allows a buyer to purchase a business based on an agreement that he or she will do so via installments spanning at least two years. The sale price must be considered fair market value and include a reasonable interest rate for the arrangement to be exempt from the gift tax.
With this option, you can sell to your designated successor for less than the company's fair market value. He or she can take over ownership without having to finance or pay outright the business's full worth. However, the new owner will owe taxes on the difference between the sale price and the fair market value, as that amount will be classified as a gift. You will also owe on the sale proceeds, though how much depends whether the buyer purchases the business outright or in installments over the course of several years.
Grantor retained annuity trust
A grantor retained annuity trust is somewhat higher risk than the other options on this list, though it also enables a business to pass from one owner to the next with few tax obligations. Under this strategy, you can establish a trust in which the business will be held for a specified number of years.
As long as the grantor retained annuity trust is in effect, you will receive annuities based on the business's appreciation. Once the trust expires, your designated beneficiary will own the business and will not owe taxes on the asset. However, if the business doesn't appreciate at a federally established interest rate, the depreciated property returns to you after the trust expires. Or, if you pass away, the property will be included in your estate and therefore subject to estate taxes.
Self-canceling installment notes
In this case, your designated buyer will sign a promissory note guaranteeing that he or she will make a series of payments in exchange for the business being transferred into his or her name. When you pass away, any outstanding payments will be canceled, and the successor will own the business. This option has two advantages, in that it provides you with regular retirement income and is not subject to gift or estate taxes.
Perhaps your intended successor is already a partner in the company, but you'd like to cede full control to them once you retire. In that case, you can negotiate a partner buyout, in which they will compensate you for your shares of the company. Ideally, an agreement on how this would unfold should have been in place when the partnership was established. But if it wasn't, you'll need to work together to find an arrangement that allows you to leave the company fairly compensated without putting it under any undue strain.
There are other choices to explore as well, including private annuities, intentionally defective grantor trusts, selling to a third party or merging with another company. The latter two may become attractive if your family members are unwilling or unable to take over the business.
A business transfer can be an emotional time, so it's best to think about what you want to do well before you retire. Doing so affords you the time to speak with potential successors and work with them and your advisory team to determine the best strategy. Whichever option you choose has significant implications for your retirement income, your family's financial stability and your legacy, so be sure to work with trusted wealth and tax professionals throughout the process.