Legal Corner: Financial and Legal Aspects of Succession Planning for Family-Owned Businesses
Smith, Stephanie M., Rural Cooperatives
As discussed in a prior Legal Corner article about business succession planning ("succession planning," hereafter), succession planning is key to protecting your company, your family and your employees against monetary burden that could leave your business in financial and legal ruins. For example, if you plan to turn over your business to your children, you have to think about the heavy gift taxes they will face. If you die, your heirs can suffer an equally prohibitive estate tax.
This is a huge issue for many rural communities, and it can have related impacts on members of farmer cooperatives. In addition to their farms, many co-op members also have related businesses (such as custom harvesting or crop application services, etc.) that may operate as family businesses.
If you want to sell your business to employees, either an employee stock option program or a worker cooperative can be organized. (see the January-February 2009 issue of Rural Cooperatives for more on this topic). Lastly, you may decide to sell your firm to a chain or a local competitor. So, where does a business owner start?
Critical issues to consider
* Valuation--No matter who inherits your business, it is critical that you get an accurate valuation of your business. Such a valuation encompasses tangible assets such as real estate and buildings, machinery and equipment, as well as intangibles such as employee loyalty, manufacturing processes, customer base and business reputation, patents on products and new technologies. A business valuation is also a way to predict your company's future. Using your firm s historical and financial records and your judgment as owner, work with your valuation firm to calculate whether your business will grow or decline, future inflation rates and anticipated costs and expenses of running the operation.
Ownership and control--A family-owned business is often held and controlled by husband, wife (or both), or a number of siblings. Other, nonfamily, closely held businesses often have a more complicated system of ownership and control. Along with ownership comes control over compensation, benefits, hiring/firing, management and short- and long-term business goals.
Management Succession--A family business must be viewed in terms of the way in which management decisions are made for non-family businesses. Non-family businesses make decisions according to performance of their employees and reward them accordingly. Those who are unproductive are terminated. However, a family-owned business usually makes decisions based upon the value of family members as people, regardless of whether their performance is satisfactory or not. If "blood is thicker than water," a concerted effort must then be made to identify and train the appropriate family members to be the successors to manage the business.
You may also have to consider nonfamily members as successors if they prove to be the key people to ensuring the sustainability of the business. In some cases, short-term successors are appointed while long-term successors complete the necessary training. Overall, the relative strengths and weaknesses of the family members must be carefully considered in determining the management restructuring that must take place.
* Tax Planning--The cash-flow consequences of succession planning are crucial to success. This is an area where the team approach of professionals can really bring value to the process. In the area of estate and gift taxes, questions need to be raised regarding lifetime transfers or transfers at death.
Should there be "carry over" basis (gifting) or "stepped up" basis (transfers at death)? What will be the death tax cost to transfer the business and how will finances be arranged to meet the obligations? In the area of income tax planning, what will the capital gains be if the entity is sold to outside parties? Are there ways that this gain can be deferred or eliminated, perhaps with charitable tax planning? …