Timothy Ridley,
Meagher & Geer:
612.338.0661
tridley@meagher.com
www.meagher.com
Want to pass down
the business?
Use aroad map
by Timothy Ridley
MANY FAMILY-RUN BUSINESSES ignore a big challenge: When it’stime to pass the company down to the next generation, are all the legal basescovered? What are the biggest drivers in securing a smooth transition?
The primary mistake, for family-owned and other businessesalike, is that the owners don’t have a formal transition plan in place. For avariety of reasons, owners would much rather consider themselves invincible.
If a plan is in place, commonly the owner will not haveprovided for sufficient liquidity to allow for either the purchase of theowner’s interest or the estate tax liability that may be incurred.
Also, there are instances where older-generation businessowners do not adequately prepare for conflicts within the next generation,which can stem from opposing views on how to handle the business itself, thestaff and external relationships.
In order to avoid these issues, the plan’s objective shouldbe the most seamless transition possible and include contingencies for eachvariable. The goal is to make sure the buyers don’t run into problems thatcould have been avoided.
Creating the plan
Transition plans consist of some sort of documentation totransfer the owner’s interest, whether it be a corporation, limited liabilitycompany or partnership. It is vital to include all the necessary paperwork.
Be sure that adequate funding is in place to ensure successnot only of the business but also the financial well-being of the transferringowner. Companies might have a transition plan in place, but the capital neededto sustain it is not as secure. If the financial foundation of the company isat risk, it’s critical to disclose such information to the family memberinheriting the business.
Reasonable contingencies need to be outlined in the plan in theevent that unforeseen circumstances arise. This tactic will ensure that thenewly appointed business leader won’t be caught in a situation withoutalternative actions.
For example, a father may transition his business to hischildren. After a few years, one or more of the children may decide that analternative career would be better. The documentation should thus contemplatehow that child’s interests should be protected or purchased. The last thing theparent wants to create is animosity between children successors.
Make reasonable arrangements with business customers toensure the enterprise thrives after the owner’s departure.
Consider accountants, lawyers and other vendors: Will thenew generation stay with the same group, or hire their own advisers?Communication will help ease the change.
Ways to transfer
Generally, business owners who transfer the business tofamily members will do so by virtue of a buy-sell agreement, a Grantor RetainedAnnuity Trust (GRAT), or an outright gift through a recapitalization of somesort.
When using a buy-sell agreement, the financing issues are ofparamount importance. The business owner will optimally be cashed out. If not,financing terms should be understood and to the greatest extent possible,guaranteed.
In transitions to family members, does the owner fund thebuy-out through an insurance program, or a gift to the next generation? Or doesthe parent insist on some stake for the next generation?
With a GRAT, the business is generally gifted atsignificantly discounted values to children, with the parents retaining an incomeright from the trust for a specified number of years. The longer the incomeinterest is retained, the longer the discount available to the parents. GRATsare used not only for transitioning the business, but also as an estateplanning tool.
With arecapitalization, typically the parents will gift non-voting shares to thechildren. This allows the parents to retain control over the operation.Recapitalizations are also primarily used for estate tax reasons.
